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A more detailed description of such factors can be found in the filings with the Securities and Exchange Commission.
Joining us for today's call are Jerry Grisko, President and Chief Executive Officer; and Ware Grove, Chief Financial Officer.
With the release of our third quarter results, I am extremely proud of our performance to date.
Our results in the third quarter and throughout this year continue to demonstrate the strength and resilience of our business.
We started this year with a good deal of optimism, especially given the performance of the business since the onset of the pandemic, the steadily increase in demand for our services that were experienced through the second half of last year and the level of confidence about the business climate that we're hearing from many of our clients.
Even with our optimistic outlook, our performance to date has exceeded our expectations.
While we oftentimes experienced some seasonal slowness in the third quarter, that has not been the case this year.
The strong demand for our core essential services that we experienced through the first half of this year has continued through the third quarter, and our results have been bolstered by very strong performance from many of our more project-oriented advisory services that are often viewed by our clients as being more discretionary.
And perhaps most encouraging, the strong performance reflected in our year-to-date results is coming from both of our major practice groups and across nearly all major service lines of our business.
Within our Financial Services group, we continue to experience strong performance from our core accounting, tax and advisory businesses.
And in addition, during the third quarter, we saw steady demand for our tax consulting services and robust demand across the board for our advisory services.
These results reflect the strength of our current business climate and the overall confidence and optimism of our clients.
As our clients take steps to capitalize on opportunities to accelerate growth in the future, these actions should translate into additional project-based advisory work for us.
Within our government healthcare consulting business, we are experiencing a rate of growth in the mid-single digits.
While this growth is consistent with our experience since the onset of the pandemic, we would expect to see accelerated growth in the months ahead as more states fully reopen and some delayed work resumes.
A complementary acquisition that provides actuarial services that we made this past summer, is creating additional opportunities for us to bring even greater value to our government clients in the administration of complex healthcare programs.
Now turning to our benefits and insurance group.
We are also experiencing the continuation of the strong performance that we saw for the first half of the year.
We continue to see steady demand for our core employee Benefits, Property & Casualty and Retirement Plan Advisory businesses.
As we've discussed on prior calls, we've made substantial investments over the past several years to accelerate organic growth within our employee benefits business by adding to the number of producers.
We are very pleased with the results that we are seeing in this area and the impact of our efforts are evidenced in our results today.
Within these results, I also want to emphasize the importance of client retention.
We continue to see retention rates of over 90% without our employee benefits business and for many of our other businesses within our benefits and insurance group.
These levels of client retention speak to the value that our clients receive from our team and our commitment to bring them solutions that are unmatched in our industries.
Within our property and casualty business, we continue to see steady demand and production for both the commercial and program components of the business.
We've described in the past earnings call how some industries like hospitality, lodging and adventure sports, were disproportionately impacted during the pandemic.
We are seeing the return of these businesses.
And while some are not yet back to pre pandemic levels, the trend is positive.
The strength of the market is also providing additional lift to our retirement investment services business and an increase in demand for more project-based work, such as our executive recruitment and our compensation consulting services.
Our payroll business is the one area where we continue to experience some softness.
As we've mentioned on previous calls, this business serves a larger number of smaller employers that continue to be disproportionately impacted by current business conditions, including labor shortages.
Overall, we couldn't be more pleased with our year-to-date results and the performance of our business.
I will remind you that during our last earnings call, we raised our full year revenue guidance.
Today, we are pleased to be in a position to raise our revenue guidance and our adjusted earnings per share guidance for the remainder of 2021 and where we'll walk through what we expect in his comments.
Our results for the third quarter and for the nine months ended September 30 continued to be very strong.
I want to take a few minutes to talk about the highlights.
With revenue up by 18.6% in the third quarter, and up by 14.5% for the nine months, demand for our core services continues to be stable and strong.
Same unit revenue for the third quarter grew by 8.3% compared with last year.
And for the nine months, same unit revenue grew by 7.3% compared with last year.
We are seeing growth in both our Financial Services group as well as the benefits and insurance group.
In the third quarter, total revenue in the Financial Services group grew by 20.4%.
And for the nine months, revenue grew by 16%.
Same unit revenue in the Financial Services group was up by 9.2% in the third quarter.
And for the nine months, same unit revenue was up by 8.7%.
We are seeing growth across all major service lines, with particularly strong growth within our advisory business services.
Within our benefits and insurance group, total revenue grew by 16.1% in the third quarter.
And for the nine months, total revenue grew by 12.4%.
Same unit revenue within benefits and insurance grew by 6.6% in the third quarter.
And for the nine months, same unit revenue grew by 4.4%.
With the exception of our payroll services, where we are experiencing some slight softness, we are seeing growth in all service lines.
The investment in producers that has been underway for some time now is continuing to show positive results.
The acquisitions we made last year and through the first nine months this year are performing well.
These newly acquired operations contributed 10.3% to total revenue growth in the third quarter and contributed 7.3% to total revenue growth for the nine months.
As we presented second quarter earnings earlier this year, we made an adjustment to eliminate the impact of the $30.5 million nonrecurring UPMC settlement that was announced on June 30, plus an adjustment to eliminate the impact of the $6.4 million nonrecurring gain on sale from a divestiture that occurred in the second quarter.
On an adjusted basis, for the nine months, adjusted earnings per share was $1.84 compared with $1.41 a year earlier.
This is up 30.5%.
In the third quarter, earnings per share was $0.41 compared with $0.36 a year ago.
In line with our comments during the second quarter call earlier this year, as we began to restore discretionary expenses, such as marketing, travel or as other healthcare benefit costs began to normalize from abnormally low COVID influence levels from a year ago.
We cautioned that expense headwinds would impact margin in the second half this year.
As a result, margin on income before tax declined in the third quarter from 11.4% a year ago to 10.3% this year.
This is not a reflection on the health of the business.
This is simply a reflection of the year-over-year pandemic influence impact on these costs, which reflect abnormally low levels a year ago.
On an adjusted basis, eliminating the nonrecurring items I mentioned, we are very pleased that margin on income before tax for the nine months has improved by 120 basis points, up to 15.2% versus 14% a year ago.
To date this year, we have closed five acquisition transactions that will contribute approximately $72 million of annualized revenue.
Through September 30, we have used $74.8 million for acquisition purposes, including earn-out payments on acquisitions closed in prior years.
Future earn-out payments are estimated at approximately $6.6 million for the balance of this year, $26.7 million in 2022, $19.3 million in 2023, $22.9 million in 2024 and approximately $6 million in 2025.
Our continuing priority is to utilize capital to enhance growth through strategic acquisitions, and we continue to have a very active pipeline of potential acquisitions.
With our strong cash flow, we also have the flexibility to repurchase shares.
Through September 30, we utilized approximately $85 million to repurchase 2.7 million shares.
And since that time, through October 26, we have repurchased an additional 258,000 shares.
As a result of these share repurchases, we expect full year share count within a range of 53.5 million to 54 million shares.
With strong revenue growth and expansion of margin, cash flow has continued to be strong.
At September 30, debt outstanding on our unsecured $400 million credit line was $190.2 million with $201.6 million of unused capacity.
Leverage under the credit facility was 1.2 times adjusted EBITDA at September 30.
As a reflection of cash flow, adjusted EBITDA for the nine months this year was $153.5 million, up 21% from $126.9 million a year ago.
Focused primarily on facility and office improvements, capital spending through September 30 was $6.5 million, with $3.2 million spent in the third quarter.
Full year spending may come in between $8 million to $10 million.
Day sales outstanding on receivables was 88 days at September 30, and this continues to reflect improvements that were gained over the past 12 to 18 months.
Bad debt expense through September 30 this year was approximately 10 basis points of revenue compared with 41 basis points a year ago.
Our effective tax rate for nine months was approximately 24.5%.
There are a number of unpredictable factors that can impact the tax rate either up or down, but we expect the effective rate for the full year within a range of 24% to 24.5%.
As we look at the remainder of the year and update guidance on our full year outlook and as you begin to compare expectations to last year, be aware of the year-over-year anomalies to the items that I mentioned earlier.
Headwinds with higher expense levels compared to last year on the same items we experienced in the third quarter, such as healthcare and benefits, travel and marketing are expected to persist for the remainder of the year.
In addition, consider that we closed several significant business acquisitions in the financial services space in midyear this year.
These operations will have a very positive full year impact on both revenue growth and contribution to earnings, and this will provide a significant tailwind for us in 2022.
However, recognizing the typical seasonality of these businesses with higher first half revenue and profitability, we are projecting a slight operating loss in these newly acquired operations in the fourth quarter this year.
One other nonoperating item to point out is the impact of the timing of vacation expense accruals.
In a normal year, vacation expense accruals are relieved throughout the year.
Last year, as we work with clients to maintain high levels of service throughout the pandemic conditions, a higher portion of vacation time was delayed into the fourth quarter.
As a result, there was a larger-than-normal fourth quarter favorable adjustment last year as vacation expense accrual was relieved.
This year, vacation accruals have followed a more normal pattern, so there is no significant favorable adjustment projected in the fourth quarter.
Of course, there is no full year impact, and this is purely a COVID influenced accounting anomaly that will be unique to the comparison of fourth quarter this year compared to fourth quarter a year ago.
With revenue up 14.5% and adjusted earnings per share up 30.5%, the health of our business is very strong.
As we consider the unique items described above that are projected to impact the balance of the year-over-year comparisons, our expectations for the full year are as follows: Total revenue growth in 2021 is expected within a range of 12% to 15% over 2020.
Adjusted earnings-per-share growth is expected within a range of 20% to 24% over the $1.42 earnings per share recorded in 2020.
We expect a full year weighted average share count within a range of 53.5 million to 54 million shares.
And unpredictable factors can impact the tax rate either up or down, but we expect a full year effective tax rate within a range of 24% to 24.5%.
Again, we are extremely pleased with the performance of the business this year.
Despite the several headwinds I described that impact the second half comparisons this year, the business is very healthy, and there are considerable growth opportunities as we look ahead.
As I discussed last quarter, we started this year with the strongest M&A pipeline that we've seen in our recent history.
The annualized revenue contribution from the five transactions that we've already closed this year will provide nice momentum going into 2022.
In addition, we continue to have a very strong pipeline, including some larger deals, and there's still opportunity for us to close one or more of these transactions before year-end.
While we are always looking ahead, I'd like to take a moment to talk about the most recent group to join our team.
F In early September, we completed the acquisition of Shea Labagh Dobberstein, and accounting, tax and advisory services firm based in San Francisco, Bay Area.
SLD serves privately held businesses, individuals and nonprofit organizations across the West Coast and has offices in San Francisco, San Mateo and Walnut Creek, California.
This acquisition is part of our long-term growth strategy on the West Coast.
SLD complements our existing geographic footprint and increases the visibility of our brand while adding valuable capacity and scale in this growing market.
Moreover, we always seek to find partners that share our commitment to client service and demonstrate a strong cultural fit and alignment on core values.
SLD checked all of these boxes and more, and we look forward to working together to bring even greater value to our teams, our clients and to accelerate growth.
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compname reports q3 earnings per share of $0.41 from continuing operations.
sees aggregate annual revenue from acquisitions of about $72 million on full year basis (not sees fy revenue about $72 million).
sees fy gaap earnings per share $1.36 to $1.42.
q3 same store sales rose 8.3 percent.
q3 earnings per share $0.41 from continuing operations.
sees fy revenue up 12 to 15 percent.
q3 revenue rose 18.6 percent to $282.7 million.
cbiz sees fy gaap earnings per share of $1.36 to $1.42.
sees fy revenue about $72 million.
|
Many factors could cause future results to differ materially.
A more detailed description of such factors can be found in our filings with the Securities and Exchange Commission.
Joining us for today's call are Jerry Grisko, President and Chief Executive Officer; and Ware Grove, Chief Financial Officer.
Throughout the past year, I emphasized the fundamental characteristics of our business that I believe enable us to continue to perform well in both favorable and less favorable business climates.
As I described on our second quarter call, these characteristics include that approximately 70% of our revenue is generated from essential services, including our tax services, insurance services, payroll services and a host of others that we provide to our clients regardless of economic conditions in the market.
We generally retain approximately 90% of our clients from year-to-year.
We have a broad geographic footprint.
We serve a diverse client base in terms of size and industry.
We enjoy strong and constant cash flow and have a substantial amount of variable expenses in our business.
Our ability to grow throughout the challenging business climate that was 2020 is a testament to those characteristics, the strength of our business model and the agility and resilience of our team.
As expected and reflected in our results, some of our businesses performed better than others in more uncertain and volatile business environments.
Generally, the essential services described earlier tend to continue to perform well even in more challenging business climates while certain more discretionary services are less predictable.
Many of our more discretionary services are in higher demand when our clients are pursuing or making decisions around growth, such as acquisitions or significant expansion plans.
We saw much of this play out during 2020.
Within our Financial Services group, we experienced strong performance from our core tax & accounting business and our litigation support business and continued steady performance from our government healthcare consulting business.
We also experienced a slowdown in the second and third quarters in demand for certain of our more discretionary project-oriented services, such as our valuation business and portions of our private equity advisory practice.
However, demand for many of those services began to rebound in the fourth quarter, particularly for those services that are tied to supporting our clients' pursuit of acquisition opportunities.
One note on our government healthcare consulting practice.
On our last call, we discussed how the rate of growth had temporarily slowed during COVID due to restrictions of access to client facilities and delays in receiving client information.
In the fourth quarter, we were pleased to see the rate of growth for that business resume to more normal levels, and we expect demand for the services provided by that business to remain strong throughout 2021.
Turning to our Benefits and Insurance group.
We had a similar experience to our Financial Services group with strong performance from the essential services that we provide, including our employee benefits business, the commercial and personal lines portion of our property and casualty business, the advisory services we provide for our clients on the retirement plans and demand for our upmarket, more robust payroll platform.
From a consolidated view, the solid results that we experienced for those services were somewhat clouded by the softer results from a relatively small portion of our property and casualty business tied to the hospitality and adventure sports, a decline in the number of payrolls processed for some of our smaller clients, particularly those tied to the restaurant industry and a number of other more project-oriented service lines.
The encouraging note here is that we expect the portions of that business that were negatively impacted by the soft economic conditions to return to more normal growth levels once the economy improves.
One last note as it relates to our Benefits and Insurance business.
We have made substantial investments over the past several years in hiring, training and supporting new producers within this group.
Those investments are essential to drive sustained long-term organic revenue growth.
The early report card on those investments is very encouraging.
And as a group, the new producers that we brought into this program are outperforming our projections.
As a result, we are continuing to invest in our new producer program and to expand this program to other business lines.
Now looking forward, we enter into this year in a position of financial strength with a very strong balance sheet, low debt and ready access to capital.
As we demonstrated in 2020, we also have a significant amount of variable expenses and considerable discretionary spending items that we can manage to preserve liquidity, if economic conditions are worse than currently anticipated.
While much remains uncertain, we expect client demand for our core essential services to remain strong and for client interest in many of our more discretionary services to increase as business conditions continue to improve.
Based on our performance in 2020, the financial strength of the business, the cost control measures that we have at our command and our current view of the business climate for 2021, we have elected to reinstate guidance for this year.
I want to caution that while we are comfortable issuing annual guidance, we do expect more volatility than we ordinarily experience when comparing a given quarter to the same period in the prior year.
So we would caution against doing so.
These assumptions include the first six to nine months of 2021 will be similar to what we experienced in the second half of 2020, and we expect continued recovery in the M&A market, which impacts many of our more project-based and private equity services.
We saw improvement in the fourth quarter and expect this trend to continue throughout 2021.
The total revenue growing by 1.6% for the full year and margin on pre-tax earnings from continuing operations increasing by 90 basis points.
We were pleased to report earnings per share of $1.42 for the full year, up 11.8% over $1.27 reported a year ago.
To recap a few important points.
As the impact of the COVID pandemic unfolded, there was considerable risk and uncertainty everywhere.
We took a number of immediate actions to protect our liquidity, and we took measures to prudently control expenses with a view toward preserving our ability to serve clients in order that we could emerge as a strong and healthy business ready to resume growth.
We have not been completely immune, but with many actions we took, coupled with the dedication of our CBIZ team, we are pleased that our business model has weathered the storm, and we are now a stronger company for the experiences in 2020.
Our primary concern operating under the pandemic environment was to protect our liquidity.
Perhaps the best measure of our success in 2020 is the continuing nature of our strong positive cash flow.
We ended 2020 with $108 million of outstanding debt on our credit facility, increasing only $2.5 million from $105.5 million at year-end a year ago.
After an active first quarter in 2020, repurchasing 1.2 million shares and closing three acquisitions, we paused both acquisitions and share repurchase activity from mid-March through mid-September until we could develop more confidence with the stability of our cash flow trends.
For the full year of '20, we closed seven acquisitions and utilized $89.7 million of capital for acquisition activities.
We also deployed $57.6 million to repurchase approximately 2.3 million shares for the full year, including the repurchase of one million shares in the fourth quarter.
For the full year, with $147.3 million of capital used for these two purposes, our borrowing increased by only $2.5 million.
This results in a leverage ratio of approximately 0.8 times on adjusted EBITDA of $132.1 million, with $286 million of unused capacity.
Going into '21, this offers us great flexibility to continue to deploy capital for acquisitions and for continuing our share repurchase activity.
Through February 16 to date this year, we have repurchased an additional 600,000 shares, and we intend to continue to repurchase shares.
With this recent activity, when combined with shares repurchased in 2020, this has resulted in the repurchase of more than 5% of our shares outstanding.
When you also consider the 1.2 million shares repurchased in the prior year 2019, we have repurchased approximately 4.1 million shares or roughly 7.5% of shares outstanding within the past two years, and we've utilized nearly $100 million of capital for these activities.
Considering our strong balance sheet and cash flow attributes, we can repurchase this level of shares without compromising our capacity for acquisitions.
With the seven acquisitions closed in 2020, plus an eighth transaction we announced effective on January one this year, collectively these newly acquired operations will generate approximately $48 million of annualized revenue.
Strategically, these acquired operations will further strengthen Benefits and Insurance services.
We'll add an important component to our financial advisory services and we'll add capacity in order to accelerate the rollout of our integrated payroll services platform that focuses on upmarket clients.
Acquisition-related payments for earn-outs from previously closed transactions are estimated at $13.6 million in 2021.
In 2022, we estimate a use of approximately $15.4 million, approximately $9.1 million in 2023, $13 million in 2024 and approximately $800,000 in 2025.
For 2020, capital spending for the full year was $11.7 million, of which $2.2 million was in the fourth quarter.
We expect capital spending within a range of $12 million to $15 million, looking ahead into 2021.
Depreciation and amortization expense for the full year of '20 was $23.1 million, $9.6 million of depreciation with $13.5 million of amortization.
In the fourth quarter, depreciation and amortization expense was $5.9 million.
A major concern for us as the pandemic unfolded in 2020 was our clients' ability to pay receivables.
As we transition to remote work conditions at the end of the first quarter in 2020, our team did a great job refining and adopting new processes and digital tools for billing and management of receivables.
These tools are now a more permanent fixture in our workflow processes and in our communication with clients.
Days sales outstanding performance on receivables improved this past year despite the volatile conditions and financial stress throughout the economy.
At the end of the year, days sales outstanding stood at 72 days compared with 75 days a year earlier.
Although not completely immune to financial stress, this is also good evidence that with our diverse client base, there is no significant concentration of clients in the more severely impacted areas of the economy, such as hospitality, travel, restaurant or entertainment businesses.
At the end of the first quarter in 2020, we recorded an additional $2 million of reserve for bad debt.
With continuing uncertainty in the economy, although days sales outstanding performance has improved, we continue to carry that level of reserves for bad debt.
For the full year of '20, bad debt expense was 45 basis points of total revenue compared with 25 basis points of total revenue for 2019.
Total consolidated revenue for the full year was up 1.6%, with same unit revenue declining slightly by 0.4%.
In the fourth quarter, total revenue grew by 3.9% and same unit revenue grew by 1.1%.
Within Financial Services, total revenue for the full year was up 2.1%, with same unit revenue up 0.8%.
In the fourth quarter, total revenue in Financial Services was up 6.6% with same unit revenue up 3.3%.
Turning to Benefits and Insurance.
For the year, total revenue grew by 0.5%, with same unit revenue declining by 3%.
And in the fourth quarter, revenue declined by 0.8% and same unit revenue declined by 3.2%.
As I indicated in our third quarter conference call, revenue growth numbers were impacted by a relatively small number of our operations, where the nature of advisory or transactional services was more severely impacted by economic conditions.
For the full year, these businesses represented 16% of our total revenue, but collectively, these businesses declined by 12.8% in 2020 compared with the prior year.
Adjusting total revenue to exclude the impact of these businesses, the remaining core revenue would reflect growth of 4.9% rather than the 1.6% reported.
Same unit revenue would reflect growth of 2.5% rather than the 0.4% decline reported.
Fourth quarter revenue adjusted to exclude these businesses, grew by 8.3% versus the reported 3.9% and same unit revenue grew by 4.7% versus the reported 1.1%.
With pre-tax income margin improving by 90 basis points to 10.7% from 9.8% the prior year, we saw a favorable impact resulting from the cost control measures we took in deferring discretionary items, plus the favorable impact from the natural reduction in travel, entertainment expense and from the lower cost for our self-funded healthcare benefits.
Among other things, for 2020, T&E costs came in at approximately 30% of the prior year levels, and healthcare costs came in at approximately 85% of expectations as discretionary and elective medical procedures were deferred.
Adjusting the reported operating margin to remove the impact of accounting for gains and losses on assets held in the deferred compensation plan, operating income was 11.2% for the full year, up 70 basis points compared with 10.5% in 2019.
As Jerry outlined, we think business conditions in 2021 will look very much like the environment we experienced during the second half of 2020.
Of course, the timing and impact of a successful COVID vaccination rollout is very unclear, and there is still risk and uncertainty ahead.
Considering the stability and performance of our core businesses in 2020, together with the impact of recent acquisitions, we think revenue will continue to grow in a similar matter, as I just described.
We are projecting total revenue growth in 2021 within a range of 5% to 8%.
As a reminder, we do not provide guidance for quarterly results.
But as you think about the year ahead, bear in mind, the first quarter last year was a relatively strong quarter before we felt a COVID impact in the second half of March.
With the 5% to 8% revenue growth expectation, we are looking to increase earnings per share within a range of 8% to 12% over the $1.42 recorded for 2020.
Consistent with our longer-term goals, we can manage a number of discretionary items, and we expect to improve margin within a range of 20 to 50 basis points.
You will note the effective tax rate was 24.3% in 2020.
Aside from any change in tax law that may arise from the new administration, there are a number of variables that can impact our tax rate, either up or down.
But as we look ahead to 2021, we are projecting a 25% effective tax rate.
Ongoing share repurchase activity will impact the fully diluted weighted average share count.
At this time, we are estimated 54.5 million fully diluted shares for the full year, down from 55.4 million shares in 2020.
As I mentioned, we are continuing to repurchase shares, and we will update this estimate at the end of the first quarter and throughout the year.
Adjusted EBITDA for 2020 came in at $132.1 million or 13.7% of revenue, a 9.6% increase from the prior year, and we expect to further improve that margin in '21.
So in conclusion, we were pleased to see stability in client demand and cash flow as we progress through the year.
We have emerged from the challenge of 2020 as a stronger company with stronger processes.
Going into 2021, we think our business will continue to reflect the stability, evidenced by the performance this past year.
We recognize the uncertainty and risks ahead, and we will plan to update our expectations as conditions dictate throughout the balance of the year.
First, I would like to talk about our unique position in the market and how it allows us to provide solutions to our clients that are unmatched in our industries.
While we have a large number of very capable competitors for many of the services we provide, they are often not aligned and lack the ability to provide the holistic, multidisciplinary solutions that our clients need when analyzing decisions that relate to their most impactful opportunities or greatest challenges.
We witnessed the strength of our business model throughout 2020 as we move quickly to collaborate across businesses, service lines and geographies to bring CBIZ's resources and expertise to bear in coordinated services that were responsive to our clients' most pressing needs.
We are encouraged by the value that our holistic multidisciplinary solutions approach brings to our clients and are excited for the opportunities that it presents for CBIZ to further distinguish us from our competitors.
Next, relating to M&A.
The acquisition of BeyondPay brings additional implementation capacity to support sales of our upmarket payroll solution and follows another similar acquisition earlier in 2020.
We also acquired Borden Perlman Insurance Agency within our property and casualty business.
Based in New Jersey, Borden Perlman is a leading provider of property and casualty insurance with an over 100-year history of serving clients on the East Coast.
Both of these acquisitions provide strategic value, but are also strong cultural fits, which is the most important factor when we consider acquisition opportunities.
As Ware mentioned, overall, we completed seven acquisitions in 2020, all of which bring expertise, capacity, talent and a strong client base to our business.
As I mentioned earlier, in 2021, we've already completed one acquisition with our core accounting and tax practices with the addition of Middle Market Advisory Group in Denver, Colorado.
MMA provides tax complying and consulting services to middle market companies and family groups across a number of attractive industries and complements our rapidly growing Colorado practice.
Acquisitions continue to be an essential component of our growth strategy.
While the M&A market slowed in the second and third quarters of last year, we are seeing activity resume.
We are finding that our performance throughout the pandemic allows us to tell a compelling story when it comes to potential partners.
The challenges faced by many of our smaller competitors throughout COVID shined a light on the value that CBIZ can bring to our team members and our clients as a result of our scale, breadth and depth of services and expertise.
As a result, our pipeline of outstanding acquisition prospects is stronger than it has been in many years, and we have access to capital to be aggressive as we seek to take advantage of many of these opportunities as we can.
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sees 2021 total revenue up 5% to 8%.
sees 2021 earnings per share from continuing operations up 8% to 12%.
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chubb.com for more information on factors that could affect these matters.
First, we have Evan Greenberg, Chairman and Chief Executive Officer; followed by Peter Enns, our Chief Financial Officer.
As you saw from the numbers, Chubb had an outstanding quarter, highlighted by record operating earnings and underwriting results, expanded margins and double-digit premium revenue growth globally, the best in over 15 years, powered by commercial P&C and supported by continued robust commercial P&C rate movement.
Chubb was built for these conditions.
We have averaged double-digit commercial P&C growth over the past 10 quarters.
The breadth of our product and reach, combined with our execution-oriented underwriting culture and our reputation for service and consistency enable us to fully capitalize on opportunity globally.
And conditions such as these size and scale are our friend.
Core operating income in the quarter was $1.62 billion or $3.62 per share, again, both records.
On both the reported and current accident year ex-cat basis, underwriting results in the quarter were simply world-class.
The published P&C combined ratio was 85.5% and current accident year was 85.4% compared to 87.4% prior year.
The two percentage points of margin improvement were almost entirely loss ratio related.
Current accident year underwriting income of $1.2 billion was up 27%.
While on the other side of the balance sheet, adjusted net investment income of $945 million, also a record, was up nearly 9.5% from prior year.
Peter will have more to say about cats and prior period development, investment income and book value.
Turning to growth and the rate environment.
P&C premiums were up 15.5% globally, with commercial premiums, excluding agriculture, up nearly 21%.
The 15.5% growth for the quarter and 12.6% for the first six months were the strongest growth we have seen since 2004.
Growth in the quarter was extremely broad-based, with contributions from virtually all commercial P&C businesses globally, from those serving large companies, to midsized and small and most regions of the world and distribution channels.
We continue to experience a needed and robust commercial P&C pricing environment in most all important regions of the world, with continued year-on-year improvement in rate to exposure on the business we wrote, both new and renewal.
Based on what we see today, I'm confident these conditions will continue.
In North America, Commercial P&C net premiums grew over 16%.
New business was up 24%, and renewal retention remained strong at 96.5% on a premium basis.
In our North America major accounts and specialty commercial business, net premiums grew over 13%, with each division, major accounts, Westchester and Bermuda having its largest quarter in history in terms of written business.
And the standout was our middle market and small commercial division, which had the biggest quarter in about 20 years, driven by record new business growth and strong retentions.
Overall rates increased in North America commercial by a strong 13.5%, which is on top of a 14.7% rate increase last year for the same business, making the two-year cumulative increase over 30%.
And remember, in North America, rates have been rising for almost four years.
However, they have exceeded loss costs for only about two years now.
Loss costs are currently trending about 5.5% and vary up or down depending upon line of business.
General commercial lines loss costs for short-tail classes are trending around 4%, while long-tail loss costs, excluding comp, are trending about 6%.
Let me give you a better sense of the rate increase movement by division and line in North America.
In major accounts, rates increased in the quarter by about 16% on top of almost 18% prior year for the same business, making the two-year cumulative increase over 36%.
Risk management-related primary casualty rates were up almost 9%.
General casualty rates were up 21% and varied by category of casualty.
Property rates were up nearly 12% and financial lines rates were up almost 20%.
In our E&S wholesale business, the cumulative two-year rate increase was 39%, comprised of an increase of circa 18% this quarter on top of 18% prior year second quarter.
Property rates were up about 16.5%.
Casualty was up about 21%, and financial lines rates were up over 21%.
In our middle market business, rates increased in the quarter over 9.5% on top of over 9% last year, making the two-year cumulative increase 20%.
Rates for property were up over 10.5%.
Casualty rates were up 11%, excluding workers' comp, and comp rates were down at about 0.5%.
Financial Lines rates were up over 17.5% in our middle market business.
Turning to our international general insurance operations.
Commercial P&C premiums grew an astonishing 33% on a published basis or 24% in constant dollars.
International retail commercial grew 27% and our London wholesale business grew 60%.
Retail commercial P&C growth varied by region, with premiums up 36.5% in our European division, with equally strong growth in both the U.K. and on the continent.
Asia Pacific was up over 29%, while our Latin America commercial lines business grew over 14.5%.
Internationally, like in the U.S., in those markets where we grew, we continued to achieve improved rate to exposure across our commercial portfolio.
In our international retail commercial P&C business, the two-year cumulative rate increase was 35% comprised of increases this quarter and prior year of 16% each.
Two territories in particular, the U.K. and Australia, stand out in terms of rate achievement.
In our U.K. business, rates increased in the quarter by 18%, on top of a 26% rate increase prior year for the same business, making the two-year cumulative increase 48%.
In Australia, the two-year cumulative rate was 42%, comprised of an increase of 23% this quarter, on top of 16% prior year.
In our London wholesale business, rates increased in the quarter by 13%, on top of a 20% rate increase prior year, so making the two-year cumulative 36%.
International markets began firming later than the U.S. And again, like with the U.S., rates has exceeded loss costs for about two years now.
Outside the U.S., loss costs are currently trending 3%, so that varies by class of business and country.
Consumer lines growth globally in the quarter continued to recover from the pandemic's effects on consumer-related activities.
Our international consumer business grew 13% in the quarter, and that's on a published basis.
It grew 5% in constant dollars.
Breaking that down for you, international personal lines grew 20% on a published basis, while our international A&H grew 6.5%, but it was essentially flat in constant dollar.
Within our A&H book, a nascent recovery in our leisure travel business outside of Asia is beginning to result in growth, although passenger travel activity is still well below pre-pandemic levels.
In both our group A&H business, with its employer-based benefits and our consumer-focused direct marketing business, premiums were up mid-single digits, still impacted by the pandemic but beginning to improve.
Net premiums in our North America high net worth personal lines business were up over 2.5%.
Nonrenewals in California and COVID auto-related renewal credits had almost one point of negative impact on growth in the quarter.
Our network client segment, the heart of our business, grew almost 8% in the quarter.
Overall retention remains strong at over 94%.
And we achieved positive pricing, which includes rate and exposure of 13% in our homeowners portfolio.
Loss cost inflation in homeowners is currently running about 11%.
Lastly, in our Asia-focused international life insurance business, net premiums plus deposits, were up 55% in the quarter, while net premiums in our Global Re business grew up -- grew over 32%.
In sum, we continue to capitalize on a hard or firming market for commercial P&C in most areas of the world.
Both growth and margin expansion are two trends that I am confident will continue.
Our organization is firing on all cylinders.
We're growing our business and our exposures, and we continue to expand our margins.
Our leadership employees are energized and driven to win.
I am confident in our ability to outperform and deliver strong, sustainable shareholder value.
I'm excited to be in my new position and build upon all that he has achieved -- all he has achieved under his leadership, and I'm honored to be leading the very strong team he has built going forward.
Turning to our results.
We completed the quarter in an excellent financial position and continue to build upon our balance sheet strength.
We have over $75 billion in capital and a AA-rated portfolio of cash and invested assets that now exceeds $123 billion.
Our record underwriting and investment performance produced strong positive operating cash flow of $3.1 billion for the quarter.
Among the capital-related actions in the quarter, we returned $2.3 billion to shareholders, including $1.9 billion in share repurchases and $352 million in dividends.
Through the six months ended June 30, we returned $3.1 billion, including $2.4 billion in share repurchases and dividends of $704 million.
We recently announced a onetime incremental share repurchase program of up to $5 billion through June 2022.
As Evan said, adjusted pre-tax net investment income for the quarter was a record $945 million, higher than our estimated range, benefiting from increased corporate bond call activity and higher private equity distributions.
We increased the size of our investment portfolio by $2.4 billion in the quarter after buybacks due to strong operating cash flow and high portfolio returns, including $694 million in pre-tax unrealized gains from falling interest rates.
At June 30, our investment portfolio remained in an unrealized gain position of $3.3 billion after tax.
During this challenging investment return environment, we will remain consistent and conservative in our investment strategy and do not expect to materially adjust the portfolio asset allocation over the near term.
We will be selective but active, and we'll continue to focus on risk-adjusted returns and we will not reach for yields.
There are a number of factors that impact the variability in investment income, including the amount of operating cash flow available to invest, the reinvestment rate environment and the assumed prepayment speeds on our corporate bond calls and variability around private equity distributions.
Based on the current interest rate environment and a normalization of bond calls and private equity distributions, we continue to expect our quarterly run rate to be approximately $900 million.
Our annualized core operating ROE and core operating return on tangible equity were 11.5% and 17.7%, respectively, for the quarter.
And as a reminder, we continue to present the fair value mark on our private equity funds outside of core operating income as realized gains and losses instead of net investment income as other companies do.
The gain from the fair value mark this quarter of $712 million after tax, we have increased core operating ROE by five percentage points to 16.5% and core operating income by $1.59 per share to $5.21.
Book and tangible book value per share increased by 4.2% and 5%, respectively, from the first quarter due to record core operating income and realized and unrealized gains of $1.4 billion after tax in our investment portfolio, which again primarily came from declining rates and mark-to-market gains on private equities.
The increase in book value per share also reflects the impact of returning over $2 billion to shareholders in the quarter.
Our pre-tax P&C net catastrophe losses for the quarter were $280 million, principally from severe U.S. weather-related events.
There was no overall change to our aggregate COVID-19 loss estimate.
We had favorable prior period development in the quarter of $268 million.
This included a charge from molestation claims of $68 million pre-tax compared with $259 million in the prior year.
Excluding this charge, we had favorable prior period development in the quarter of $336 million pre-tax, split approximately 30% in long-tail lines, principally from accident years 2017 and prior and 70% short-tail lines.
For the quarter, our net loss reserves increased $1.1 billion in constant dollars and our paid-to-incurred ratio was 80%.
Our core operating effective tax rate was 15.8% for the quarter, which is within our expected range of 15% to 17% for the year.
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compname reports strong second quarter net income per share of $5.06 and record core operating income per share of $3.62.
consolidated net premiums written up 14.3% globally, with commercial p&c lines up 19.9%; best organic p&c growth in over 15 years.
q2 core operating earnings per share $3.62.
qtrly p&c combined ratio was 85.5% compared with 112.3% prior year.
qtrly pre-tax catastrophe losses, net of reinsurance and including reinstatement premiums was $280 million.
p&c net premiums written were up 15.5% globally for quarter.
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chubb.com for more information on factors that could affect these matters.
First, we have Evan Greenberg, Chairman and Chief Executive Officer, followed by Peter Enns, our Chief Financial Officer.
We had a very strong third quarter, highlighted by outstanding P&C premium revenue growth globally of 17% and simply excellent underwriting results on both the calendar and current accident year basis, despite elevated catastrophe losses.
Our results were powered by double-digit commercial lines growth, strong continued underlying margin expansion, the strength of our reserves and our broad diversification of businesses.
Core operating income in the quarter of $2.64 per share was up 32% with $250 million over prior year to $1.2 billion, while net income of $1.8 billion was up 53% from prior year.
For the year on both a net and core operating income basis, we have produced record earnings.
Again, it was an active quarter for natural catastrophes.
Yet, with over $1.1 billion of cats, we reported a 93.4% combined ratio with P&C underwriting income up 58% to $617 million, which speaks to the underlying strength of our businesses, and again, broad diversification of our company's sources of revenue and earnings, both domestically and globally.
Year-to-date, we have produced $2.4 billion in underwriting income for a combined ratio of 90.4% and that includes $2.1 billion of cat losses, and what is shaping up to be another year of sizable weather-related loss events kind of the new normal brought on by climate change and other societal changes.
Speaking again to our underwriting health, on a current accident year ex-cat basis, underwriting income in the quarter was $1.4 billion, up 23% with a combined ratio of 84.8% compared to 85.7% prior year, a quarterly underwriting record.
If we exclude the one-time positive adjustment we took last year due to lower frequency of loss because of the COVID-related shutdown, our current accident year combined ratio unaffected improved 2 points.
The strength of our balance sheet and conservative approach to loss reserving was again in evidence this quarter as we reported $321 million in favorable prior period reserve development.
Net investment income in the quarter was $940 million, up 4.5%.
Peter is going to have more to say about cats and prior period development, investment income and book value.
Turning to growth in the rate environment.
As I said at the opening, P&C premiums were up nearly 17% globally or 15.5% in constant dollar with commercial premiums up 22% and consumer up 4%.
The 17% growth for the quarter and 14.2% for the first nine months, topped last quarters and was the strongest organic growth we have seen again since 2004.
Growth in the quarter was broad-based with contributions virtually all commercial P&C businesses globally from our agriculture business to those serving large companies to mid-sized and small and most regions of the world and distribution channels.
The robust commercial P&C pricing environment remains on pace in most all important regions of the world with continued year-on-year improvement in rate to exposure on the business we wrote, both new and renewal.
In North America, total P&C net premiums grew over 17% with commercial premium up about 22.5% excluding agriculture, which had a fantastic quarter in its own right with premium growth of over 40%, commercial P&C premiums were up over 16.5% in North America.
New business was up 13% for all commercial lines and renewal retention remained strong at over 97% on a premium basis.
The 16.5% commercial premium growth is a composite of 15.5% growth in our major accounts and specialty business and over 18% in our middle market and small commercial business, simply a standout quarter for this division.
Overall, rates increased in North America commercial lines by over 12%.
Once again, loss costs are currently trending about 5.5% and vary up or down, depending upon line of business.
And again, like last quarter, just to remind you, in general, commercial lines loss costs for short-tail classes are trending around 4% though we anticipated this to increase in the future while long-tail loss costs excluding comp are trending about 6%.
Let me give you a better sense of the rate increase movement in North America.
In major accounts, which serves the largest companies in America rates increased in the quarter by just over 13%.
Risk management-related primary casualty rates were up over 6%.
General casualty rates were up about 21% and varied by category of casualty.
Property rates were up 12% and financial lines rates were up 17%.
In our E&S wholesale business, rates increased by 16% in the quarter, property rates were up 13%, casualty was up 20% and financial lines rates were up about 21%.
In our middle market business, rates increased in the quarter nearly 9.5%.
Rates for property were up over 11%.
Casualty rates were up about 9.5% excluding workers' comp with comp rates down 2% and financial lines rates were up 18%.
Turning to our international general insurance operations.
Commercial P&C premiums grew 20.5% on a published basis or 16% in constant dollar.
International retail commercial P&C grew nearly 17% or 12% in constant dollar, while our London wholesale business grew over 31%.
Retail commercial P&C growth varied by region with premiums up almost 28% in our European Division, Asia Pacific was up 15.5%, while Latin America commercial lines grew about 6.5%.
Internationally, like in the U.S. in those markets where we grew, we continued to achieve improved rate to exposure across our commercial portfolio.
In our international retail commercial P&C business, rates increased in the quarter by 15%, property rates were up 11%, financial lines up 33% and primary and excess casualty up 7% and 11% respectively.
And in our London wholesale business rates increased in the quarter by 11%, property up 13%, financial lines up 14%, marine up 8%.
Outside North America, loss costs are currently trending about 3% though that varies by class of business and country.
Consumer lines growth globally in the quarter continue to recover from the pandemic's ongoing effects on consumer-related activities.
Our international consumer business grew almost 10% in the quarter on a published basis or 5% in constant dollar, and breaking that down a little further, international personal lines grew almost 11% on a published basis, while international A&H grew over 8.5% or just 5% in constant dollar.
Latin America had a particularly strong quarter in consumer with personal lines and A&H premiums up 18.5% and 17.5% respectively, powered by both our traditional and digitally focused distribution relationships.
Net premiums in our North America high net-worth personal lines business were up just over 1%, adjusted for non-renewals in California and COVID related auto-renewal credit, we grew 3% in the quarter.
Our true high net-worth client segment, the heart of our business, grew 11% in the quarter.
Overall, retentions remained strong at 95.7% and we achieve positive pricing, which includes rate and exposure of 14% in our homeowners portfolio.
The severity trends in personal lines in the U.S. remain elevated.
Lastly, in our Asia-focused international life insurance business, net premiums plus deposits were up over 52% in the quarter, while net premiums in our Global Re business were up over 22%.
In sum, we continue to capitalize on broad-based and favorable market conditions and improving economic conditions.
All of our businesses did well or are improving from agriculture to all forms of commercial P&C globally, both retail and wholesale, serving large companies to middle market and small to our improving global personal lines and A&H businesses to our Asia life businesses, to our Global Re business.
In one sentence, both growth and margin expansion are two trends that will continue.
In the quarter, as you saw, we announced the definitive agreement to acquire the life and non-life insurance companies that house the personal accident supplemental health and life insurance businesses of Cigna and Asia-Pacific for $5.75 billion in cash.
This highly complementary transaction advances our strategy to expand our presence in the Asia-Pacific region, including our company's Asia-based life company presence and add significantly to our already sizable global A&H business.
Upon completion of the transaction, which we expect during 2022, Asia Pacific share of Chubb's global portfolio will represent approximately 20% of the company.
For many years, we have admired Cigna's business in Asia including its people, product innovation, distribution and management capabilities.
The underlying economics and value creation of the transaction are very attractive, and these businesses will contribute to our company strategically for decades to come.
The transaction once again demonstrates our patience in advancing our strategies and confirms our consistent and disciplined approach to holding capital for risk and growth, both organic and inorganic.
Our company has considerable earning power and a patient hand to deploy capital effectively over time.
We return excess of what we need to shareholders in the form of dividends and share repurchases, while we continue to build future revenue and earnings generation capabilities.
In conclusion, this was another excellent quarter of growing our business and our exposures, expanding our margins and investing in our future.
All in a period with substantial cats, which are not unexpected.
My management team and I have never been more confident in our ability to continue to outperform and deliver strong sustainable shareholder value.
As you've just heard from Evan, our overall franchise continues to deliver outstanding top line growth, margin improvement and profit growth.
Now let me discuss our balance sheet and capital management.
Our financial position remains exceptionally strong, including our cash flow, liquidity, investment portfolio, reserves and capital.
It all starts with our operating performance, which produced $3.3 billion in operating cash flow for the quarter and $8.5 billion for the first nine months.
We continue to remain extremely liquid with cash and short-term investments of $5.1 billion at the end of the quarter even after our significant capital management actions.
Among the capital related actions in the quarter, we returned $1.9 billion to shareholders, including $1.5 billion in share repurchases and $346 million in dividends.
Through the nine months ended September 30th, we returned over $5 billion, including almost $4 billion in share repurchases or over 5% of our outstanding shares and dividends of over $1 billion.
The agreement to acquire Cigna's A&H and life insurance businesses in Asia-Pacific is not expected to impact our share repurchase and dividend commitments.
Our investment portfolio of $122 billion continues to be of a very high quality and we have not made any material changes during the quarter to our investment allocation.
The portfolio increased $759 million in the quarter and at September 30th our investment portfolio remained in an unrealized gain position of $2.9 billion after-tax.
Adjusted pre-tax net investment income for the quarter was $940 million similar to last quarter and $40 million higher than our estimated range benefiting from higher private equity distributions.
As I noted on the second quarter earnings call, our investment income is based on many factors, and notwithstanding our better than expected results over the last few quarters, we continue to expect our quarterly run rate to be approximately $900 million.
Pre-tax catastrophe losses for the quarter were $1.1 billion with about $1 billion in the U.S., of which $806 million was from Hurricane Ida and $135 million from international events, of which $95 million was from flood losses in Europe.
Our reserve position remains strong, with net reserves increasing $1.7 billion or 3.2% on a constant dollar basis reflecting the impact of catastrophe losses in the quarter and 2021 growth, in particular from our agricultural business which has a seasonality impact on reserves.
We had favorable prior period development of $321 million pre-tax which include $33 million of adverse development related to legacy environmental exposures.
The remaining favorable development of $354 million was split approximately 30% in long-tail lines, principally from accident years 2017 and prior and 70% in short-tail lines, principally from our 2020 North American personal lines.
Our paid-to-incurred ratio was 73% or a very strong 75% after adjusting for cats, PPD and agriculture.
Book value decreased by $744 million or 1%, reflecting $1.16 billion in core operating income and a net gain on our investment portfolio of $190 million, which was more than offset by foreign exchange losses of $305 million and the $1.9 billion of share repurchases and dividends.
Book and tangible book value per share increased 0.6% and 0.4% respectively from last quarter.
Our reported ROE for the quarter and year-to-date was 12.3% and 14.4% respectively.
Our core operating ROE and core operating return on tangible equity were 8.2% and 12.6% respectively for the quarter.
As a reminder, we do not include the fair value mark on our private equity funds in core operating income as many of our peer companies do.
For comparison purposes, our core operating ROE increases by 5 percentage points to 13.2% and our core operating income increases by a $1.61 per share to $4.25.
Year-to-date, our core operating ROE, including the fair value mark on our PE funds would be 13.8%.
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compname reports third quarter per share net income and core operating income of $4.18 and $2.64, up 59% and 32%, respectively.
consolidated net premiums written up 15.8%, with commercial p&c lines up 22%.
q3 core operating earnings per share $2.64.
qtrly p&c combined ratio was 93.4% compared to 95.2% prior year.
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In addition, today's call includes discussions of certain non-GAAP financial measures.
Tables reconciling these non-GAAP financial measures are available in the supplemental information package in the Investors section of the company's website at crowncastle.com.
As you saw from our results yesterday, we remained on track to generate an anticipated 12% growth in AFFO per share this year.
We expect to be at the high end of our long-term growth target in 2022, with 8% AFFO per share growth.
Being driven in large part by our expectation at tower core leasing activity will be approximately 50% higher in 2022 than our trailing 5-year average.
And we increased our annualized common stock dividend by approximately 11% to $5.88 per share, marking the second consecutive year of dividend growth that meaningfully exceeds our long-term target.
Given that our dividend payout ratio has remained largely unchanged since 2014, our dividend remains the best indicator of how we are performing both financially and operationally.
Our significant out-performance in 2021 combined with our forecast for 2022 enabled us to raise our dividend 11%, well above our stated goal for the second year in a row.
In essence, we've achieved three years of targeted dividend growth in just two years.
Since we established our common stock dividend in 2014, we have grown dividends per share at a compounded annual growth rate of 9% with growth ranging from 7% to 11% in each year.
We aim to provide profitable solutions to connect communities and people.
And our carbon-neutral goal builds on our commitments to deploy our strategy sustainably.
Our business model is inherently sustainable, shared solutions limit infrastructure in the communities in which we operate and minimize the use of natural resources.
Further to the point, our core value proposition, since we began operating more than 25 years ago has centered around our ability to provide our customers with access to mission-critical infrastructure at a lower cost, because we can share that infrastructure across multiple operators.
In addition, our solutions help address societal challenges like the digital divide in under-served communities by advancing access to education and technology.
To-date, we have invested nearly $10 billion in towers, small cells and fiber assets located in low-income areas.
As a way of quantifying how our business model minimizes the use of natural resources, our business in it's just one ton of CO2 per $1 billion of enterprise value, which is 90 times more efficient than the average company in the S&P 500 based on industry estimates.
Although we are proud of our limited environmental impact, we are focused on making even more strides by reducing our energy consumption and sourcing renewable energy to help us achieve our goal of carbon neutrality by 2025.
We are excited about this announcement and look forward to continuing to find ways to help our communities and planet while driving significant returns to our shareholders.
Turning back to our 2022 outlook.
We are benefiting from record levels of activity in our tower business with our customers upgrading thousands of existing cell sites as a part of their first phase of 5G build-out.
Adding to the opportunity, we are seeing the highest level of tower co-location activity in our history with DISH building a nationwide 5G network from scratch.
I believe our strategy and unmatched portfolio of more than 40,000 towers and approximately 80,000 route miles of fiber concentrated in the top U.S. market, have positioned Crown Castle to capitalize both on the current environment and to grow our cash flows and dividends per share in the near term and for years to come.
We are focused on generating this growth while delivering the highest risk adjusted returns for our shareholders.
By investing in shared infrastructure assets that lower the implementation and operating costs for our customers while generating solid returns for our shareholders.
To execute on this strategy, we are providing our customers with access to our 40,000 towers and 80,000 route miles of fiber help them build out their 5G wireless networks.
We are investing in new small cell and fiber assets that meet our disciplined and rigorous underwriting standards to expand our long-term addressable market.
And we are identifying where wireless networks are going and investing early to position the company to capitalize on future opportunities, as we have done with small cells, edge computing and CBRS.
One of the core principles underpinning our strategy is to focus on the U.S. market, because we believe that represents the best market in the world for wireless infrastructure ownership, since it has the most attractive growth profile and the lowest risk.
And we believe this dynamic of higher growth and lower risk will continue into the future, which is why we expect our U.S. based strategy will drive significant returns for shareholders.
With that in mind, we have invested nearly $40 billion in towers, small cells and fiber assets in the top market that are all foundational for the development of future 5G network.
We believe our unique strategy, portfolio of the infrastructure assets and proactive identification of future opportunities provide a platform for sustained long-term dividend growth as wireless network architecture evolves and our customers' priorities shift over time.
Today, our customers are primarily focusing their investment on macro sites as towers remain the most cost-effective way to deploy spectrum at scale and established broad network coverage.
With our high quality towers concentrated in the top markets, we are clearly benefiting from this focus with an expected 6% organic growth for our Tower segment in 2021 and an expected 20% increase in tower core leasing activity next year when compared to these 2021 levels.
With history as a guide, we believe the deployment of additional spectrum on existing cell sites will not be enough to keep pace with the persistent 30% plus annual growth in mobile data traffic.
As a result, we expect cell site densification to remain a critical tool for carriers to respond to the continued growth in mobile data demand as it enables our customers to get the most out of their spectrum assets by reusing the spectrum over shorter and shorter distances.
When the current cell site upgrade phase shift to densification phase, we believe the comprehensive offering of towers, small cells and fiber will be critical for our customers and provide us with an opportunity to further extend the runway of growth in our business.
While we expect the densification phase of build out will drive additional leasing on our tower assets for years to come, we believe small cells will play an even greater role as the coverage area of cell sites will continue to shrink due to the density of people and therefore the density of wireless data demand.
With more than 80,000 small cells on air or committed in our backlog, high capacity fiber assets and the vast majority of the top 30 markets in the U.S. and industry-leading capabilities, we believe we are well positioned to deliver value to our customers as their priorities evolve, driving meaningful growth in our small cell business.
Bigger picture, when I consider the durability of the underlying demand trends we see in the U.S., how well we are positioned to consistently deliver growth through all phases of the 5G build out with significant potential upside in our comprehensive asset base as wireless networks continue to evolve.
Our proven ability to proactively identify where wireless network architecture is heading and to be an early investor in solutions to help future networks, the deliberate decisions we have made to reduce risks associated with our strategy and our history of steady execution.
I believe that Crown Castle stands out as a unique investment, that will generate compelling returns over time.
In the near term, as I mentioned before, we expect to deliver outsized AFFO per share growth of 12% in 2021.
We expect to generate 8% growth in AFFO per share in 2022 at the high end of our long-term growth target and supported by an expected 20% increase in tower core leasing activity and we increased our common stock dividend by 11% for the second consecutive year.
Longer term, we believe Crown Castle provides an exciting opportunity for shareholders to invest in the development of 5G in the U.S., which we believe is the best market for communications infrastructure ownership.
Importantly, we provide access to such attractive industry dynamics, while providing a compelling total return opportunity, comprised of a high-quality dividend that currently yields 3.5% with expected growth in that dividend of 7% to 8% annually.
As Jay discussed, we delivered another great quarter of results in the third quarter.
We remained on track to grow AFFO per share by an anticipated 12% this year.
We expect to be at the high end of our growth target in 2022 with 8% AFFO per share growth and we increased our quarterly common stock dividend by 11% for the second consecutive year, meaningfully above our long-term target growth rate while maintaining a consistent payout ratio.
We are excited about the outsized growth we are experiencing in the early stages of 5G.
And we continue to believe our portfolio of towers, small cells and fiber provides unmatched exposure to what we believe will be a decade-long build out by our customers.
Our third quarter results were highlighted by 8% growth in site rental revenues, 11% growth in adjusted EBITDA and 13% growth in AFFO per share when compared to the same period last year.
Record tower activity level supported this strong growth, generating organic tower growth of 6.3% and higher services contribution when compared to the same period in 2020.
Looking at our full-year outlook for 2021 and 2022 on Slide 5.
We are maintaining our 2021 outlook with site rental revenues, adjusted EBITDA and AFFO growing 7%, 11% and 14% respectively.
For full year 2022, we expect continuing investments in 5G to drive another very good year for us, with 5% site rental revenue growth, 6% growth in adjusted EBITDA and 8% AFFO growth.
Turning now to Slide 6.
The full year 2022 outlook includes an expected organic contribution to Site Rental revenues of $245 million to $285 million or 5%, consisting of approximately 5.5% growth from towers, 5% growth from small cells and 3% growth from fiber solutions.
To address feedback we received to provide more detail around our expectations for future leasing -- for the leasing activity, we have introduced a new concept of core leasing activity, which excludes the impact of changes in prepaid rent amortization.
Core leasing activity is more indicative of current period activity, whereas changes in prepaid rent amortization also include activity from prior periods as prepaid rent received in those prior periods eventually amortizes the zero over the life of the associated contract.
Although we have as consistently provided disclosure on prepaid rent amortization by segment in our supplemental earnings materials.
With that definition in mind, we expect 2022 core leasing activity of $340 million at the midpoint or $350 million inclusive of the year-over-year change in prepaid rent amortization.
The 2022 expected core leasing activity includes a $160 million in towers, representing a 20% increase when compared to our 2021 outlook and an approximately 50% increase when compared to our 5-year trailing average.
$30 million in small cells compared to $45 million in $2021 and a $150 million in fiber solutions compared to a $165 million expected this year.
Turning to Slide 7.
You can see, we expect approximately 90% of the Organic Site Rental Revenue growth to flow through the AFFO growth, highlighting the strong operating leverage in our business.
As we discussed in July, we expect to deploy an additional 5,000 small cells in 2022, which is the same number we expect to build in 2021.
We expect a discretionary capex to be approximately $1.1 billion to $1.2 billion in 2022, including approximately $300 million for towers and $800 million to $900 million for fiber, similar to what we expect in 2021.
This translates to $700 million to $800 million of net capex when factoring in $400 million of prepaid rent contribution we expect to receive in 2022.
The full year 2022 outlook for capex represents an expected 30% reduction in discretionary capex for our fiber segment relative to full year 2022 when we deployed approximately 10,000 small cells.
Based on the expected growth in cash flows, for full year 2022 and consistent with our investment grade credit profile, we expect to fund our discretionary capex with free cash flow and incremental debt capacity without the need for new equity for the fourth consecutive year.
In addition, we believe our business and balance sheet are well positioned to support consistent AFFO growth through various economic cycles, including during periods of higher inflation and interest rates.
Our cost structure is largely fixed in nature as you can see, with nearly 90% of the full year 2022 expected Organic Site Rental Revenue growth to flow through to AFFO growth as I referenced earlier.
And we have taken steps to further strengthen our investment grade balance sheet, that now has more than 90% fixed rate debt, a weighted average maturity of more than 9 years and a weighted average interest rate of 3.1%.
In conclusion, we are excited about the outsized growth we are generating as a result of the initial 5G build out by our customers, which is translating into back-to-back years of 11% growth in our quarterly common stock dividend.
This dividend currently equates to an approximate 3.5% yield, which we believe is a compelling valuation given our expectation of growing the dividend 7% to 8% per year, combined with our high quality, predictable and stable cash flows.
Looking further out, we believe our unique ability to offer towers, small cells and fiber solutions, which are all integral components of communications networks provides significant optionality to capitalize on the long-term positive industry trends of network improvements and densification and gives us the best opportunity to consistently deliver growth as wireless network architecture continues to evolve and our customers' priorities shift over time.
With that, April, I'd like to open the call to questions.
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compname reports third quarter 2021 results, provides outlook for full year 2022 and announces 11% increase to common stock dividend.
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Actual results could vary materially from such statements.
Earnings for the quarter were $1.57 per share compared to $0.65 in the prior year quarter.
Adjusted earnings per share increased to $1.83 in the quarter compared to $1.13 in 2020.
Net sales in the quarter were up 12% from the prior year, primarily due to increased volumes across all segments, favorable foreign currency translation and the pass through of higher material costs.
Segment income improved to $433 million in the quarter compared to $298 million in the prior year, primarily due to higher sales unit volumes, favorable price cost mix and the non-recurrence of charges for tinplate carryover costs that we saw in 2020.
As outlined in the release, we currently estimate second quarter 2021 adjusted earnings of between $1.70 and $1.80 per share.
This estimate includes the results of the European tinplate business, which will be reported as discontinued operations beginning with the second quarter results.
We are maintaining our full year adjusted earnings guidance of $6.60 to $6.80 per share.
Assuming the sale of the European tinplate business closures at the beginning of the third quarter, we expect that the earnings dilution impact over the balance of the year of about $0.50 per share will be offset by improved results in the remaining operations as compared to our original guidance.
Our expected tax rate for the year remains at 24% to 25%.
Demand was strong across all major businesses and despite the ongoing challenges posed by the pandemic and severe winter weather in the United States the company continue to convert strong volume growth into record earnings.
This performance could not have been possible without great people and our global associates continue to perform extraordinarily in the face of the pandemic, ensuring that our customers receive high quality products and services in a safe and timely manner.
And while it feels that we're turning the corner with widespread vaccinations now available.
New streams and increased positivity rates in some jurisdictions remind us that we must remain vigilant in our adherence to recommended behaviors.
Global demand continues to be very strong for the beverage can and we are committed to deploying necessary capital to meet customer needs.
As detailed in last night's release, we expect to commercialize 6 billion units a beverage can capacity in 2021 with further investments being made to bring on at least that much more in 2022.
Before reviewing the operating segments we thought it would be well to remind you that delivered aluminum in North America sit around $1.28 a pound versus $0.75 a pound last year at this time, so an increase of 70%.
And as we contractually pass through the LME and the delivery premium, reported revenues will reflect both volume increases and the higher aluminum cost this year.
In Americas Beverage, demand remained strong across all of the markets we serve with overall segment volumes up 9% in the first quarter.
We expect that demand will continue to outweigh supply for the foreseeable future.
And as described to you in February, we have eight production lines in various stages of construction to bring more supply to these markets during 2021 and 2022.
While the CMI no longer publishes industry volumes, we can tell you that our North American volumes increased 12% in the first quarter compared to the same prior year period.
Unit volumes in European Beverage increased 6% in the first quarter as growth across Northwest Europe and the Mediterranean offset softness in Saudi Arabia.
Segment income reflects contribution from the volume growth and the two aluminum lines in Seville, Spain, which were down for conversion in last year's first quarter.
Sales unit volumes in European Food increased 6% in the first quarter as the business continues to benefit from strong consumer demand for packaged food.
Segment income which almost doubled the prior-year amount reflects the above noted volume growth.
$5 million of favorable foreign exchange and the negative impact of tinplate carryover included in the prior year first quarter.
As reported on April 8, 2021, the company entered into an agreement to sell its European tinplate businesses, which includes European Food.
And as Tom said, we expect the sale to be completed in the third quarter and beginning with the second quarter, results will be reflected in discontinued operations.
Asia-Pacific reported 8% volume growth in the first quarter as both Southeast Asia up 5% and China up more than 30%, continue to show recovery from the pandemic related shutdowns.
As described in February, activity levels are returning.
However, we expect there will be virus-related shutdowns and movement control orders from time to time across the region throughout 2021.
Excluding foreign exchange, results for Transit Packaging were in line with the prior year with industrial demand surging, activity remains extremely strong in Transit and we expect this segment will post full year segment income growth of approximately 25% in 2021 over 2020.
There will be a large outperformance in the second quarter against an easy comp with further gains through the end of the year.
Other operations also reported strong results in the first quarter led by North American Food and our beverage can making equipment businesses.
In summary, a great start to 2021.
With numerous projects completed last year and several more under way currently, we remain well positioned to continue to capture our share of global beverage can growth.
Importantly, we continue to convert growth into expanded earnings and cash flow.
As Tom discussed, our full year guidance remains unchanged, despite expected dilution from the sale of the European tinplate businesses.
Better than expected first quarter performance combined with continued strong demand across beverage and transit will allow us to earn through sale-related dilution and a rising commodity cost environment.
And just before we open the call to questions, we ask you that you limit yourselves to two questions initially so that everyone will have a chance to ask their question.
But always as -- feel free to jump back into the queue.
And with that, Dale, we're now ready to open the call to questions.
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compname reports q1 adjusted earnings per share $1.83.
q1 adjusted earnings per share $1.83.
q1 earnings per share $1.57.
sees q2 adjusted earnings per share $1.70 to $1.80.
sees fy adjusted earnings per share $6.60 to $6.80.
qtrly global beverage can volumes grew 8%.
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Earnings for the quarter was $0.79 per share compared to $1.59 in the prior year quarter.
Adjusted earnings per share increased to $2.03 in the quarter compared to $1.96 in 2020.
Net sales in the quarter were up 17% from the prior year, primarily due to the pass through of higher material costs and increased beverage can and transit packaging volumes.
Segment income improved to $379 million in the quarter compared to $367 million in the prior year, primarily due to higher sales unit volumes.
As outlined in the release, we currently estimate fourth quarter 2021 adjusted earnings of between $1.50 and $1.55 per share, and full-year adjusted earnings of $7.50 to $7.55 per share.
Our expected adjusted tax rate for the year is between 23% and 24% consistent with our nine months rate.
Our continued best wishes for the continued health and safety of you and your families.
Before reviewing the third quarter results, we want to again express our sincere appreciation to our global associates for their continued efforts during the ongoing pandemic, with many of us now vaccinated, we're moving in the right direction, but we should expect the next several months to remain challenging as COVID variance make their way through various populations.
Again, we ask all of you to remain vigilant in protecting yourselves, your family members, your associates and your communities.
Demand remained strong across all product lines and geographies with the exception of Vietnam, where hard lockdown measures by the government essentially curtailed all business and consumer activity for much of the third quarter.
We expect Vietnam will slowly reopen during the fourth quarter.
Reported revenues increased 17% during the quarter as higher beverage and transit volumes coupled with the pass through of raw material cost increases offset supply chain challenges.
In the face of these challenges, we continue to grow earnings.
And in July, we discussed with you the step change in earnings that we have experienced beginning with last year's third quarter in which EBITDA over the last five quarters averages approximately $100 million more than the previous six quarters.
Our teams continue to do a great job commercializing new capacity, converting that capacity into income growth and we look forward to more capacity coming online over the next several quarters.
We're also pleased to report that our efforts related to the environment and sustainability have not gone unnoticed.
In September, ESG ratings provider Sustainalytics again ranked Crown in the top position for mitigating ESG risk within the metal and glass packaging sector.
Also during the quarter, the Company joined the Climate Pledge, where we have committed to be net zero carbon by the year 2040.
The sale of the European Tinplate businesses was completed on August 31st, and going forward, our share of net profits will be reflected in equity earnings.
As discussed previously, we continue to experience inflationary pressure across all businesses.
Many of our businesses contractually pass through higher costs, including steel and aluminum, but some businesses will have a timing lag to recovery.
As cost for pass-through revenues will increase, however, percentage margins will decline due to the denominator effect of one-to-one pass-throughs.
Before reviewing the operating segments, we remind you that delivered aluminum here in North America is approximately 75%, 80% higher today than at this time last year.
LME and delivery premiums are contractual pass-throughs, so reported beverage revenues reflect both the volume increase and the higher aluminum cost.
After reading the various analyst reports on magnesium and related aluminum supply, I would say that many of you have a very good understanding of the situation.
The concerns related to magnesium as many of you have noted relate to energy curtailments in China.
China has restarted some production recently, so hopefully that eases some of the concerns recently voiced in Europe.
There is magnesium production here in the United States, so we have less concern on domestic supply.
And in the near term, we do not believe we have any supply concerns over the next six months, although we continue to monitor our suppliers supply.
In Americas beverage, overall unit volumes advanced 4% in the quarter as continued strong demand in North America and Mexico offset a difficult third quarter comparison in Brazil.
Our third quarter 2021 volumes in Brazil were more than 10% higher than the third quarter of 2019.
However, third quarter 2020 volumes were up 30% over the third quarter of '19, as that country rebounded sharply from the second quarter 2020 pandemic lockdowns.
A combination of -- we were never going to have enough cans in our inventories compared to the prior year and a pullback in consumer spending related to inflation concerns led to the lower sales this year.
We have seen consumer slowdowns in the past in Brazil, however, the market has always recovered to even higher levels.
Late in the third quarter, we began commercial shipments from the second line in the Bowling Green, Kentucky plant, with the third line in Olympia, Washington, now operational here in early fourth quarter.
Next month, we will begin operations in the second line in Rio Verde, Brazil, followed by a late first quarter 2022 start-up on the second line in Monterrey, Mexico.
New two-line plants in Uberaba, Brazil; and Martinsville, Virginia will come online late in 2022 followed by the new two-line plant in Mesquite, Nevada scheduled for a mid 2023 start-up.
A lot of activity, but the team is fully committed to continue our growth with a well-balanced customer portfolio.
Unit volumes in European beverage advanced 5% over the prior year with strong volumes across most operations in this segment.
Inflation offset unit volume growth with freight, utilities and labor being most notable and with inflation expected to remain elevated across Europe, we project the income will decline in the European segment in the fourth quarter and during 2022.
In Asia Pacific, unit volumes declined 8% in the quarter owing entirely to a 55% contraction in Vietnam.
Excluding Vietnam, unit volumes grew 20% in the quarter.
The Vietnamese government instituted hard lockdown measures to curb the spread of COVID and its variance.
And for example, a hard lockdown means that you're not allowed to leave your house, and the army will deliver to you all food and essentials.
And while we expect Vietnam will slowly reopen during the fourth quarter, we do expect that from time-to-time we will be subject to various lockdowns or movement control orders as the various countries look to prevent the spread of COVID.
Our new plant in Vung Tau, Vietnam, is now qualified to begin commercial shipments to customers.
As expected, transit packaging had another strong quarter, recording double-digit gains in revenues and segment income, volume growth in steel strap tooling and across protective packaging offset inflationary headwinds, notably freight.
The business continues to navigate supply shortages, transportation delays and inflation, and remains well positioned to continue to grow earnings in the fourth quarter and through next year as these conditions ease over time.
Performance in our North American food and beverage can making equipment businesses remain firm throughout the third quarter, and earlier in the year we commenced operations at a new food can plant in Dubuque, Iowa.
And during the third quarter, we began commercial shipments from a new two-piece food can line in our Hanover, Pennsylvania plant.
These line additions provide much needed capacity to our domestic supply footprint, allowing us to eliminate imports and we expect significant improvement earnings from food in 2022 as these new lines come through their learning curves.
So in summary, a very strong first nine months of 2021 with EBITDA up 26%.
As described earlier, we have several capacity projects recently completed and are underway and are pleased to reconfirm the 2025 EBITDA estimate of $2.5 billion first provided during the May virtual Investor Day.
And near-term, while we may experience inflation and supply chain related headwinds over the next few quarters, we currently expect 2022 will be another strong year of earnings growth with EBITDA estimated to be approximately $2 billion.
In addition to North American food, our beverage can businesses in North America and Brazil and our transit packaging business are all expected to have strong years in 2022, allowing us to earn through the dilution related to the European asset sale and headwinds from a persistent inflationary environment.
Before opening the call to questions, there are a number of you in the queue, so we ask that you please limit yourselves to no more than two questions so that others will have a chance to ask their question.
And with that Annie, I think we're now ready to take questions.
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compname reports q3 earnings per share $0.79.
q3 adjusted earnings per share $2.03.
q3 earnings per share $0.79.
sees q4 adjusted earnings per share $1.50 to $1.55.
sees fy adjusted earnings per share $7.50 to $7.55.
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I'll start today with a review of guest cruise operations, along with a summary of our first quarter cash flows.
Then I'll provide an update on booking trends and finish up with adjusted EBITDA and net income expectations.
Turning to guest cruise operations.
During the first quarter 2022, we restarted 10 additional ships, resulting in 60% of our fleet capacity in guest cruise operations for the whole of the first quarter.
This was a substantial increase from 47% during the fourth quarter 2021.
As of today, 75% of our fleet capacity has resumed guest cruise operations.
Agility to continuously adapt to the ever changing landscape has been one of our greatest strengths during the pandemic.
In the first quarter, we continued to demonstrate this scale as we adjusted restart dates to optimize our guest cruise operations.
And we now expect each brand's full fleet to be back in guest cruise operations for its respective summer season where we historically generate the largest share of our operating income.
I am happy to report that just last week, we announced plans for our Australia restart, commencing at the end of May after the government advised that cruising would be permitted beginning in April.
For the first quarter, occupancy was 54% across the ships in service.
We never expected to achieve our historical 100-plus percent occupancies for the first quarter since many of these sailings were confirmed just a number of months before departure, which resulted in less than the normal booking lead time.
However, we had anticipated first quarter occupancy would exceed the 58% achieved in the fourth quarter of 2021.
We started the quarter with over 55% cabin occupancy booked for the first quarter and expected to improve upon that during the quarter.
However, during the first quarter 2022, as a result of the omicron variant, we experienced an impact on bookings for near-term sailings, including higher cancellations resulting from an increase in pretravel positive test results, challenges in the availability of timely pretravel tests and disruption than omicron caused on society during this time.
All of this inhibited our ability to build on our cabin occupancy book position for the first quarter 2022 during the first quarter, resulting in occupancy for the first quarter 2022 at 54% being lower than the 58% occupancy we achieved in the fourth quarter of 2021.
Despite all that, during the first quarter, we carried over one million guests, which was nearly a 20% increase from the fourth quarter 2021.
Once again, our brands executed extremely well with Net Promoter Scores continuing at elevated levels compared to pre-COVID scores.
Revenue per passenger day for the first quarter 2022 increased approximately 7.5% compared to a strong 2019 despite our lucrative world cruises and exotic voyages being shelved this year.
Our revenue management teams held on price when we experienced an impact on bookings for near-term sailings, optimizing our longer-term prospects for future revenue and pricing.
Once again, our onboard and other revenue per diems were up significantly in the first quarter 2022 versus the first quarter 2019, in part due to the bundled packages as well as onboard credits utilized by guests from cruises canceled during the pause.
We had great growth in onboard and other per diems on both sides of the Atlantic.
Increases in bar, casino, shops, spa and Internet led the way onboard.
Over the past 2.5 years, we have offered and our guests have chosen more and more bundled package options.
In the end, we will see the benefit of these bundled packages in onboard and other revenue.
As a result of these bundled packages, the line between passenger ticket and onboard revenue is blurred.
For accounting purposes, we allocate the total price paid by the guests between the two categories.
Therefore, the best way to judge our performance is by reference to our total cruise revenue metrics.
On the cost side, our adjusted cruise cost without fuel per available lower berth day, or ALBD as it is more commonly called, for the first quarter 2022 was up 25%.
I did say adjusted cruise costs and not net cruise costs, a term we had previously used.
The calculation of adjusted cruise costs and net cruise costs are the same.
The increase in adjusted cruise costs without fuel per ALBD is driven essentially by five things: first, the cost of a portion of the fleet being in pause status; second, restart related expenses; third, 15 ships being in dry dock during the quarter, which resulted in nearly double the number of dry dock days during the first quarter versus the first quarter 2019; fourth, the cost of maintaining enhanced health and safety protocols; and finally, inflation.
Remember, that because a portion of the fleet was in pause status during the first quarter and the higher number of dry dock days, we spread costs over less ALBDs.
This will again result in a doubling of the dry dock days during the quarter compared to 2019, which will impact adjusted cruise cost without fuel per ALBD during the second quarter.
We anticipate that many of these costs and expenses driving adjusted cruise costs without fuel per ALBD higher will end during 2022 and will not reoccur in 2023.
As a result of all of the above, we expect to see a significant improvement in adjusted cruise costs, excluding fuel per ALBD, from the first half of 2022 to the second half of 2022 with a low double-digit increase expected for the full year 2022 compared to 2019.
Next, I'll provide a summary of our first quarter cash flows.
We ended the first quarter 2022 with $7.2 billion in liquidity versus $9.4 million at the end of the fourth quarter.
Looking forward, we believe we remain well positioned given our liquidity.
The change in liquidity during the quarter was driven essentially by four things: first, an improved negative adjusted EBITDA of $1 billion due to our ongoing resumption of guest cruise operations despite the impact of the omicron variant.
We had thought adjusted EBITDA was going to improve more.
But as I said before, the omicron variant inhibited our ability to grow occupancy during the quarter, which limited the improvement in adjusted EBITDA.
Second, our investment of $400 million in capital expenditures net of export credits.
Third, $500 million of debt principal payments.
And fourth, $400 million of interest expense during the quarter.
Now let's look at booking trends.
Since the middle of January, we have seen an improving trend in booking volumes for future sailings.
Recent weekly booking volumes have been higher than at any point since the restart of guest cruise operations.
During the first quarter, we increased our booked occupancy position for the second half of 2022, albeit not at the same pace as a typical wave season due to the omicron variant.
As a result, the cumulative advanced book position for the second half of 2022 is at the lower end of the historical range.
However, we believe we are well situated with our current second half 2022 book position given the recent improvement in booking volumes, coupled with closer in booking patterns and our expectation for an extended wave season.
We continue to expect that occupancy will build throughout 2022 and return to historical levels in 2023.
And importantly, I am happy to report that prices on these bookings for the second half of 2022 continue to be higher with or without future cruise credits, or more commonly called FCCs, normalized for bundled packages as compared to 2019 sailings.
Our cumulative advanced book position for the first half of 2023 continues to be at the higher end of the historical range, also at higher prices with or without FCCs normalized for bundled packages as compared to 2019 sailings.
This is a great achievement given pricing on bookings for 2019 sailings is a tough comparison as that was a high watermark for historical yields.
I will finish up with our adjusted EBITDA and net income expectations.
We all know that booking trends are a leading indicator of the health of our business.
With improved recent booking trends leading the way, driving customer deposits higher, positive adjusted EBITDA is clearly within our sights.
Over the next few months, we expect ship level cash contribution to grow as more ships return to service and as we build on our occupancy percentages.
However, as I've already said, adjusted EBITDA over the first half of 2022 has been or will be impacted by the restart-related spending and dry dock expenses as 39 ships, over 40% of our fleet, will have been in dry dock during the first half of fiscal 2022.
Given all these factors combined, we expect monthly adjusted EBITDA to continue to improve and turn consistently positive at the beginning of our summer season.
We continue to expect a net loss for the second quarter of 2022 on both a U.S. GAAP and adjusted basis.
However, we expect the profit for the third quarter of 2022.
For the full year, we do expect a net loss.
Looking to brighter days ahead in 2023, with the full fleet back in service all year, 8% more capacity than 2019 and improved fleet profile with nearly a quarter of our capacity consisting of newly delivered ships, continuing momentum on our outstanding Net Promoter Scores and occupancy returning to historical levels, we are looking forward to providing memorable vacation experiences to nearly 14 million guests and generating potentially greater adjusted EBITDA than 2019.
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q1 2022 ended with $7.2 billion of liquidity, including cash, short-term investments and borrowings.
for cruise segments, revenue per passenger cruise day ("pcd") for q1 of 2022 increased approximately 7.5% compared to a strong 2019.
as of march 22, 2022, 75% of company's capacity had resumed guest cruise operations.
since middle of january, company has seen an improving trend in weekly booking volumes for future sailings.
recent weekly booking volumes have been higher than at any point since restart of guest cruise operations.
occupancy in q1 of 2022 was 54%, a 20% increase in guests carried over prior quarter.
expects to have each brand's full fleet back in guest cruise operations for its respective summer season.
believes monthly adjusted ebitda will turn positive at beginning of its summer season.
expect improvement in occupancy throughout 2022 until it returns to historical levels in 2023.
expects adjusted cruise costs excluding fuel per albd for full year 2022, to be significantly higher than 2019.
anticipates that many of costs and expenses will end in 2022 and will not reoccur in 2023.
expects to see a significant improvement in adjusted cruise costs excluding fuel per albd from first half of 2022 to second half of 2022.
company continues to expect a net loss for q2 of 2022 on both a u.s. gaap and adjusted basis.
expects a profit for q3 of 2022.
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I'm Arnold Donald, President and CEO of Carnival Corporation & plc.
Today, I'm joined telephonically by our Chairman, Micky Arison, as well as David Bernstein, our Chief Financial Officer; and Beth Roberts, Senior Vice President, Investor Relations.
We are absolutely thrilled to be back doing what we do best, delivering amazing, memorable vacation experiences to our guests.
Our team members are overjoyed to be back on board and it shows our guests are having a phenomenal time.
Our onboard revenues for guests are off the charts, and our Net Promoter Scores have been exceptionally strong.
I've had the pleasure of visiting a number of ships in recent weeks, both here in the U.S. and abroad.
And I can tell you, the ship looks spectacular, and the crew has an amazing energy.
There is such an incredible spirit on board.
Our protocols have been working well, beginning with a seamless embarkation experience and have enabled us to build occupancy levels at a significant pace as we return more ships to service.
Our brands executed extremely well in this initial phase of our return to serve, particularly given significant restrictions on international travel, hampering our ability to offer our normal content-rich deployment options, as well as the operating requirements in certain jurisdictions that limit our normally high occupancy levels.
Our itinerary planners came up with creative deployment alternatives, our marketing department made them accessible with little investment, our yield managers priced them appropriately to achieve occupancy targets very close to them, and coupled them with bundled packages to drive exceptionally strong revenue on board.
And despite all the additional protocols, our crew delivered an amazing guest experience.
The combination of which enabled us to deliver cruise vacations at scale while producing significant cash from these restricted voyages.
Now while we normally don't disclose this level of information, we try to find a way to give you a sense of why we're viewing the restart as hugely successful beyond the enthusiasm of our guests and crew and the unprecedented Net Promoter Scores.
It became complicated because most of our voyages, while cash flow positive, are programs that could not be compared to 2019.
And in most cases, would normally be priced lower than the 2019 alternatives.
So for example, in the U.K., we're only able to offer senior cruises without any ports of call, and that's our version of vacation, which were not comparable in ticket prices to peak season Mediterranean or Baltic sailings offered in the summer of 2019.
That said, even with occupancy limitations, these cruises generated cash for our stakeholders.
They supported a return for our workforce, and they successfully served guests, resulting in high satisfaction levels.
Now at Carnival Cruise Line, we were able to offer more comparable itineraries than 2019, our revenue per dims were up 20% compared to 2019 and that's inclusive of the impact of incentives from previous cancellations, and that's despite the quoting nature of the bookings.
In fact, Carnival Cruise Lines restarted more ships out of the United States than any of the cruise brand and still achieved occupancy above 70%, all of which combined to generate an even greater cash contribution.
Clearly, Carnival Cruise Line is a brand that continues to outperform.
While the Delta variant and its corresponding effect on consumer confidence has certainly created a myriad of operating challenges for us to navigate in the near term and has led to some booking volatility in August, to-date it has not had a significant impact on our ultimate plan to return our full fleet to guest operations in the spring of 2022.
On our last quarterly business update, we said that we expected the environment to remain dynamic and it certainly have.
Of course, agility has been a key strength of ours over the last 18 months, and we continue to aggressively manage to optimize given this ever-changing landscape.
In fact, while by design, we're not yet at 100% occupancy.
We have individual sailings with over 4,000 guests.
To-date, we have carried over 0.5 million guests this year already.
And on any given day, we are now successfully carrying around 50,000 guests, and expect that number to continue to rise as we introduce more capacity and as we increase occupancy over the coming months.
The Delta variant has clearly impacted our protocols, which will continue to evolve based on the local environment.
In markets like the U.S., where case counts are higher, we've taken swift actions to reinforce our already strong protocol, such as additional testing requirements and indoor mass requirements with all U.S. sailings operating under the CDC's vaccination requirements.
Our protocols go above and beyond the terms of the conditional sale order and are much more rigorous than comparable land-based alternative.
Again, our highest responsibility and therefore, our top priority is always compliance, environmental protection and the health, safety and well-being of everyone, our guests, the people in the communities we touch and serve and of course, our Carnival family, our team members shipboard and shoreside.
The Delta variant has also created some disruption in our supply chain, impacted the timing of opening for some destinations and created a heightened level of uncertainty that has been reflected in the broader travel sector and in our own booking trends.
We quickly adjusted our deployment to push out the start date on a few select voyages.
For some of our more exotic winter deployments, like our popular world cruises, we rebooked guests for our 2023 departures.
Effectively, we've managed our near-term capacity to optimize the current environment, just as we indicated we would.
The modifications we've made to the pace of the roll of our fleet will optimize our cash position in the near term.
Looking forward, we continue to work toward resuming full operations in the spring, in time for our important summer season where we make the lion's share of our operating profit.
Of course, we have ample liquidity to see us through to full operation.
And we continue with a prudent focus on cash management to ensure we have flexibility under a multitude of scenarios.
The current environment, while choppy, has improved dramatically since last summer, and it should improve even further by next summer if the current trend of vaccine rollout and advancements in therapies continues.
For instance, in markets like the U.K., where vaccination rates are already higher, consumer confidence remains strong, and we are seeing strong momentum.
So far, we've announced the resumption of guest cruise operations for 71 ships through next spring, and that's across eight of our nine brands.
We're evaluating the remaining shifts through next spring, with a continued focus on maximizing future cash flow while delivering a great guest experience in a way that serves the best interest of public health.
Importantly, even at this very early stage of our rollout, our ships are generating positive cash flow.
Based on our current rollout, we expect cash from operations for the whole company to turn positive at some point early next year.
Looking forward, we believe we have the potential to generate higher EBITDA in 2023 compared to 2019, given despite our modest growth rate, additional capacity and our improved cost structure.
As further insight into booking trends, we are well positioned to build on a solid book position and intentionally constrained capacity for the remainder of 2021 and into the first half of 2022.
With the existing demand and limited capacity, we are focused on maintaining price.
Even recently with heightened uncertainty from the Delta variant affecting travel decisions broadly, we continue to maintain price.
We have also opened bookings earlier for cruises in 2023, and we're achieving those early bookings with strong demand and good prices.
And based on that success, we've begun to launch 2024 sailings even earlier.
In fact, these efforts contributed to the $630 million increase in guest deposits, our long-term guest deposits.
And that's deposits on bookings beyond 12 months, are 3 times historical levels, driven in part by our proactive efforts to open more inventory for sale in outer years.
Now we expect guests deposits to continue to grow through the restart as we return more ships to service and as we build occupancy levels.
Again, these favorable trends continue despite dramatically reduced advertising expense.
We continue to focus our efforts on our lower cost channels like direct marketing to our sizable past guest database of over 40 million guests, and earned media, as we build on our multiple new ship launches and restart news flow.
Of course, and most importantly, we are delivering on our guest experience.
Word-of-mouth remains the number-one reason people take their first cruise.
And as I mentioned, our Net Promoter Scores are well above historical levels across our ships that have returned to service so far.
During the quarter, we furthered our strong track record of responsibly managing the balance sheet.
We completed two refinancing transactions, among other efforts, resulting in a meaningful reduction in annual interest expense.
We have many more opportunities for refinancing ahead and are working through them at an aggressive pace.
Also importantly, we have continued to make advancements in our sustainability efforts.
Last week, we published our 11th Annual Sustainability Report, Sustainable from Ship to Shore, which can be found on our sustainability website www.
In the report, we build on the achievement of our 2020 goal by sharing more details on our 2030 goals and our 2050 aspiration.
The report shares additional light on the six focus areas that will guide our long-term sustainability vision, including climate action, circular economy -- that's wage reduction, sustainable tourism, health and well-being, diversity, equity and inclusion and biodiversity and conservation.
Now these areas align with United Nations' Sustainable Development Goals.
Climate action is a top sustainability focus area.
We are committed to decarbonization, and we aspire to be carbon neutral by 2050.
As we have previously shared, despite 25% capacity growth since that time, our absolute carbon emissions peaked in 2011 and will remain below those levels.
We are working toward transitioning our energy needs to alternative fuels and investing in new low-carbon technologies.
Now because of the pause in guest cruise operations, the 2020 sustainability performance measures are not comparable to prior year data.
That said, there is a lot of valuable information on the progress we made in our sustainability journey despite what an incredibly challenging year.
We were clearly among the most impacted companies by COVID-19, and I'm very proud of all we've accomplished collectively to sustain our organization through these challenging times, including all we did for our loyal guests, all we did for our other many stakeholders, and all we did for each other within our Carnival family.
In many regards, I believe our collective response to the pandemic is strong testimony to the sustainability of our company.
For that, I again express my deepest appreciation to our Carnival team members, both shipboard and shoreside, who consistently went above and beyond.
I'm very humbled by the dedication I've seen in these past 18 months.
We continue to move forward in a very positive way.
Throughout the pause, we've been proactively managing to resume operations as an even stronger operating company.
Our strategic decision to accelerate the exit of 19 ships left us with a more efficient and effective fleet, and has lowered our capacity growth to roughly 2.5% compounded annually from 2019 through 2025, and that's down from 4.5% pre-COVID.
We've opportunistically rebalanced our portfolio through the ship exits as well as a future ship transfer, any modification to our newbuild schedule to optimize our asset allocation, maximize cash generation and improve our return on invested capital.
While capacity growth is constrained, we will benefit from an exciting roster of new ships spread across our brands, enabling us to capitalize on the pent-up demand and drive even more enthusiasm and excitement around our restart plan.
And we will achieve a structural benefit to unit costs in 2023 as we introduce these new, larger and more efficient ships, coupled with the 19 ships leaving the fleet, which were among our least efficient, with the aggressive actions we've already taken, optimizing our portfolio and reducing capacity.
We are well positioned to capitalize on pent-up demand and to emerge a leaner, more efficient company, reinforcing our global industry-leading position.
We have secured sufficient liquidity to see us through to full operation.
Once we return the full operation, our cash flow will be the primary driver to return to investment-grade credit over time, creating greater shareholder value.
I'll start today with a review of our guest cruise operations along with our third quarter monthly average cash burn rate.
Then I'll provide an update on booking trends and finish up with some insights into our refinancing activity.
Turning to guest cruise operations.
It feels so great to be talking about operations again.
We started the quarter with just five ships in service.
During the third quarter, we successfully restarted ships across eight of our brands.
We ended the quarter with 35% of our fleet capacity in service.
Our plans call for another 27 ships to restart guest cruise operations during the fourth quarter and the month of December.
So on New Year's Day, we anticipate celebrating with 55 ships or nearly 65% of our fleet capacity back in service.
For the third quarter, occupancy was 54% across the ships in service.
Our brands executed extremely well.
Occupancy did improve month-to-month through the quarter and in the month of August, occupancy reached 59% from 39% in June and 51% in July.
Occupancy for our North American brands reflects our approach of vaccinated cruises, which for the time being, does limit the number of families with children under 12 that can sail with us.
Occupancy for our European brands reflects capacity restrictions, such as social distancing requirements for our Continental European brands and a 1,000-person cap per sailing for some of the quarter in the U.K. For the full third quarter, our North American brands occupancy was 68%, while for our European brands, occupancy was 47%.
Revenue per passenger cruise day for the third quarter 2021 increased compared to a strong 2019 despite the current constraints on itinerary offerings which did not include many of the higher-yielding destination-rich itineraries offered in 2019.
As Arnold indicated, our guests are having a phenomenal time and our Net Promoter Scores have been incredibly strong.
As always, happy guests seem to translate into improved onboard revenue.
Our onboard and other revenue per diems were up significantly in the third quarter 2021 versus the third quarter 2019, in part due to the bundled packages as well as onboard credits utilized by guests from cruises canceled during the pause.
We had great growth in onboard and other per diems on both sides of the Atlantic.
Increases in bar, casino, shops, spa and Internet led the way on board.
Over the past two years, we have offered and our guests have chosen more and more bundled package options.
In the end, we will see the benefit of these bundled packages in onboard and other revenue as we did during the third quarter 2021.
As a result of these bundled packages, the line between passenger ticket revenue and onboard revenue seems to be blurring.
For accounting purposes, we allocate the total price paid by the guests between the two categories.
Therefore, the best way to judge our performance is by reference to our total cruise revenue metrics.
As we previously guided, the ships in service during the third quarter were, in fact, cash flow positive.
They generated nearly $90 million of ship level cash contribution.
This was achieved with only a two-month U.S.-based restart during the third quarter as our North American brands began guest cruise operations in early July.
We expect the ship level cash contribution to grow over time as more ships return to service and as we build on our occupancy percentages.
For those of you who are modeling our future results, I did want to point out that due to the cost of a portion of our fleet being in pause status during the first half of 2022, restart related expenses and the cost of maintaining enhanced health and safety protocols, we are projecting ship operating expenses in 2022 per available lower berth day or per ALBD, as it is more commonly called, to be higher than 2019 despite the benefit we get from the 19 smaller, less efficient ships leaving the fleet.
Remember, that because a portion of the fleet will be in pause status during the first half, we are spreading costs over less ALBDs.
We do anticipate that most of these costs and expenses will end with 2022 and will not reoccur in fiscal 2023.
Now let's look at our monthly average cash burn rate.
For the third quarter 2021, our cash burn rate was $510 million per month, which was better than our previous guidance and was in line with the $500 million per month for the first half of 2021.
The improvement versus our guidance was due to the timing of capital expenditures, which are now likely to occur in the fourth quarter and some other small working capital changes.
With the timing of certain capital expenditures now shifting to the fourth quarter, the company expects its monthly average cash burn rate for the fourth quarter to be higher than the monthly average rate for the first nine months of the year.
Other good news positive factors impacting the fourth quarter are restart expenditures to support not only the 22 ships that will restart during the fourth quarter but also the additional ships that will restart in the first quarter of 2022, along with the significant increase in dry dock days during the fourth quarter, driven by the restart schedule.
All these expenditures have been anticipated, and given the announced restarts, many of them are now occurring in the fourth quarter.
Also, during the fourth quarter, we are forecasting positive cash flow from the 50 ships that will have guest cruise operations during the quarter.
And ALBDs for the fourth quarter are expected to be 10.3 million, which is approximately 47% of our total fleet capacity.
Now turning to booking trends.
Our booking volumes for the all future cruises during the third quarter 2021 were higher than booking volumes during the first quarter.
That trend continued over the first couple of months of the third quarter, such that we expected the third quarter would end at higher booking levels than the second quarter, but we did manage to achieve that because of lower booking volumes in the month of August when the Delta variant impacted travel and leisure bookings generally.
The impact on bookings in August was mostly seen on near-term sailings.
However, the impact quickly stabilized in the month of August.
Our cumulative advanced book position for the second half of 2022 is ahead of a very strong 2019 and is at a new historical high.
Pricing on our second half 2022 book position is higher than pricing on bookings at the same time for 2019 sailings, driven in part by the bundled pricing strategy for a number of our brands, but excluding the dilutive impact of future cruise credits or more commonly known as FCCs.
If we were to include the dilutive impact of future cruise credits, pricing on our second half 2022 book position is now in line with pricing at the same time for 2019 sailings.
This improved position is a result of positive pricing trends we have seen during the third quarter.
This is a great achievement, given pricing on bookings for 2019 sailings is a tough comparison as that was the high watermark for historical yield.
Finally, I will finish up with some insights into our refinancing activity.
We are focused on pursuing refinancing opportunities to extend maturities and reduce interest expense.
To-date, through our debt management efforts, we have reduced our future annual interest expense by over $250 million per year.
And we have completed cumulative debt principal payment extensions of approximately $4 billion, improving our future liquidity position.
The $4 billion extension results from three things: first, the July refinancing of 50% of our first lien notes were $2 billion.
Second, the completion of the European debt holiday amendments, which deferred $1.7 billion of principal payments.
The deferred principal payments will instead be made over a five-year period, beginning in April 2022.
And third, the extension of a $300 million bilateral loan with one of our banking partners.
As we look forward, given how support of the debt capital market investors and commercial banks have been, we will be pursuing additional refinancing opportunities to meaningfully reduce our interest expense and extend our maturities over time.
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carnival corporation & plc provides third quarter 2021 business update.
carnival corp - booking volumes for all future cruises during q3 of 2021 were higher than booking volumes during q1 of 2021.
carnival corp - cumulative advanced bookings for second half of 2022 are ahead of a very strong 2019.
carnival corp - voyages for q3 of 2021 were cash flow positive and company expects this to continue.
carnival - booking volumes for all future cruises during q3 of 2021 were higher than booking volumes during q1 2021, albeit not as robust as q2 2021.
carnival corp - monthly average cash burn rate for q3 of 2021 was $510 million.
carnival corp - also opened bookings for further out cruises in 2023, with unprecedented early demand.
carnival corp - company expects monthly average cash burn rate for q4 to be higher than the prior quarters of 2021.
carnival corp - expects monthly average cash burn rate for q4 to be higher than prior quarters of 2021.
carnival corp - expects a net loss on both a u.s. gaap and adjusted basis for quarter and year ending november 30, 2021.
carnival - consistent with gradual resumption of guest cruise operations, continues to expect to have full fleet back in operation in spring 2022.
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I'm Arnold Donald, President and CEO of Carnival Corporation and PLC; and today I'm joined telephonically by our Chairman, Micky Arison; as well as by David Bernstein, our Chief Financial Officer; and by Beth, Robert Vice President, Investor Relations.
What a difference a year made.
We are clearly on our way back to full cruise operations with with 50 ships now serving guests as we end the fiscal year, and that's up from just one ship, one short a year ago.
We've already returned over 65,000 crew members to our ships and thus resuming operations, over 1.2 million guests and counting and still we are [Phonetic] Now we've achieved that while delivering an exceptional guest experience with historically high net promoter scores.
These are strong accomplishment, especially in light of the uncertainty we faced just one year ago when vaccines were not yet available and effective protocols to mitigate the spread of the virus were still evolving.
Today, our team members and the vast majority of guests have received vaccines and many have received boosters.
We have [Indecipherable] the effective protocols for COVID-19 and its very enabling occupancy to progress toward historical lows.
In fact, occupancies at our Carnival Cruise Line brand which currently operates and generates that are most similar to its normally [Indecipherable] generates are now approaching 90% and that's after the impact of the variants on near-term book.
Again, Carnival Cruise Lines continues to outperform with both occupancy and price.
Even at this early stage, as a company, we are now generating meaningful cash flow at the ship level to date and growth, helping to fund start-up costs for the remaining fleet.
Total customer deposits have grown by over $1.2 billion from the prior year alone as our book position continues to build and to strength.
Importantly, we ended the year with $9.4 billion of liquidity and as essentially the same liquidity level as last year, but with significantly improved cash flow generation ahead, as the aforementioned ship operating cash flows and [Indecipherable] continue to build, with 68% of our capacity now in operation and the remainder planned by spring, we are well positioned for our important summer season, where we historically have the lion's share of our operating profit.
Throughout 2021, we said that we expected the environment to remain dynamic and it certainly has.
Of course, [Indecipherable] has been a key strength of ours and we continue to aggressively manage to optimize given this ever changing landscape as we have demonstrated through the Delta variant and now with Omicron, we have navigated near term operational challenges.
While the variants and their corresponding effect on consumer confidence have created some near term booking volatility, out book position has remained resilient.
And in the case of Delta variant, already recovered.
Importantly, these variants have not had a significant impact on our ultimate plan to return our full fleet to guest operations in the spring of 2022.
It is clear we have maximized our return to service in 2021 and we have positioned the company well to withstand the potential volatility on our path to profitability.
At the same time, we have not lost sight of our highest responsibility and therefore our top priorities, which is always compliance, environmental protection and the health, safety and well-being of everyone, that's our guests, the people in the communities we touch and serve, and of course, our Carnival family, our team members shipboard and shoreside.
And to that end, we've achieved many important milestone along the way in our return service, or events, broadening our commitments to ESG with introduction of our 2030 sustainability goals and our 2050 aspiration, and that's building on the successful achievement of our 2020 goal, increase our ESG disclosure by incorporating SASB be and TCFD framework in our sustainability report, bolstering our compliance efforts with the addition of a new Board member with valuable compliance experience, a strong addition to our Board of Directors and our Board Compliance Committee, improving our culture through emphasizing essential behaviors and incorporating them into our ethos [Phonetic] through training and development and through every day real time feedback, as we are already among the most diverse companies in the world with a global employee base representing over 130 countries.
We're focusing our efforts on diversity and inclusion at every level and in all areas of our operation.
And of course, there are many more operational milestones, such as reopening our eight owned and operated private destinations and port facilities, Princess [Indecipherable] Mahogany Bay, Amber Cove [Indecipherable] Santa Cruz de Tenerife and Barcelona, all delivering an exceptional experience to over 630,000 of the 1.2 million guests that's resuming.
Welcoming nine new more efficient ships across our world-leading brand, including Mardi Gras powered by LNG.
Mardi Gras is nothing short of a gamechanger for our namesake brand Carnival Cruise Line, premium brand Holland America introduced the new Rotterdam, sister ships to the very successful Koningsdam and Nieuw Statendam.
For the U.K., we successfully introduced Iona, also powered by LNG.
For Germany, we shortly take delivery about six LNG powered ship AIDAcosma system to the also highly successful AIDAnova.
And for Southern Europe, Costa Firenze and LNG powered Costa Toscana will replace the exit of several less efficient ships.
Now these new ship Mardi Gras, Iona, Costa Toscana have joined AIDAnova and Costa Smeralda to be the only and with the addition of AIDAcosma shortly.
The only six large cruise ships in the world currently powered by LNG, demonstrating our leading edge decarbonization efforts.
Now while the utilization of LNG is a positive step with the environment, so LNG is inherently 20% more carbon efficient.
It is not our ultimate solution.
We have announced our net zero aspirations by 2050.
Now where there is no known answer to zero carbon emissions in our industry at this time, we are working to be part of the solution.
We have and expect to continue to demonstrate leadership and executing carbon reduction strategy.
We are focused on decreasing our unit fuel consumption today, reducing even the need for carbon offsets.
Our decarbonization efforts have enabled us to peak our absolute carbon emissions way back in 2011, and that's despite an approximately 25% capacity growth since that time.
And while today based on publicly available information, we believe we are the only major cruise operator to peak our absolute emissions, our entire industry is moving in the right direction.
And as a company with a 25% reduction in carbon intensity already under our belt, we are well positioned to achieve our 40% reduction goal by 200 and are working hard to reach that deliverable ahead of schedule.
Now in addition to our cutting edge LNG efforts, we have many other ongoing efforts to accelerate decarbonization.
To name just a few, they include itinerary optimization and technology upgrades to or existing fleet and an investment of over $350 million in areas such as air conditioning, waste management lighting, and of course, the list goes on.
We are actively increasing our shore power capabilities.
Greater than 45% of our fleet is already equipped to connect the shore power and we plan to reach at least 60% by 2030.
Now we helped develop the first port with show power capability for cruise ships, leading to the development of 21 ports to date and counting.
We are focused on expanding shore power to our high value ports around the world, that includes Miami; Southampton, England; and Hamburg, Germany.
So ultimately achieve net zero emissions over time, we are investing in research and development, partly on projects to evaluate and pilot maritime skill battery and fuel cell technology and working with Classification Societies and engine manufacturers to assess hydrogen, methanol as well as bio synthetic fuels, as future low carbon fuel options for our cruise ships.
Also, these efforts combined with the exit of 19 less efficient ships are forecasted to deliver upon return to full operation a 10% reduction in unit fuel consumption on an annualized base.
Now that's a significant achievement on our path to decarbonization.
Our strategic assist to accelerate the exit of 19 ships vessels with a more efficient and a more effective fleet overall and it's lowered our capacity growth to roughly 2.5% compounded annually from 2019 through 2025, now that's down from 4.5% annually pre COVID.
While capacity growth is constrained, we will benefit from this exciting roster of new ships spread across our brand and they even to capitalize on the pent-up demand and drive even more enthusiasm around our restart plans.
A enjoy a further structural benefit to revenue from these enhanced guest experiences, new ship, due to the richer mix of premium price balcony cabins, which will increase 6 percentage points to 55% of our fleet in 2023.
Now of course, as we mentioned before, we've also achieved a structural benefit to unit costs as we deliver these new, larger, more efficient ships, coupled with the exit of 19 less efficient ships, it will help generate a 4% reduction in ship level unit cost going forward, enabling us to deliver more revenue to the bottom line.
Upon returning to full operation, nearly 50% of our capacity will consist of these newly delivered, larger, more efficient ships, expediting our return to profitability and improving our return on invested capital.
Now we are clearly resuming operation as a more efficient operating company, and we'll use our cash flow strength to reduce our leverage on our path back to investment grade credit.
Last quarter, we discussed the initial impact of the Delta variant.
We indicated we saw an impact on near-term booking volumes in the month of March.
Booking volumes have since accelerated sequentially and returned to pre-delta levels in November.
And as we said we would, we maintain price despite the disruption, achieving 4% higher revenue per passenger cruise day in our fourth quarter than in the fourth quarter of 2019.
In fact, the Carnival Cruise Line brand where we as I mentioned are able to offer more comparable itineraries to those in 2019 experienced its second consecutive quarter of double-digit revenue growth for the year, while improving occupancy with nearly 60% of its capacity returned to serve.
Now that's a testament to the fundamental strength in demand for our cruise product, especially when you consider this was accomplished without the benefit of a major advertisement.
We expect to build on this momentum with the brands announcement just last week on its Funderstruck campaign, engineered to highlight the joy and following of our Carnival Cruise.
That advertising campaign is launching over the holiday, including the activations on Christmas Day and Times Square on New Year's Eve, in time for our [Indecipherable] something that's very present in the news today, Omicron there.
We have also experienced some initial impact on near-term bookings, although difficult to measure.
That said, we have a solid book position and intensely constrained capacity for the first half of 2022.
With the existing demand and limited capacity, we remain focused on maintaining price.
Bookings continue to build for the remainder of 2022 and well into 2023, and we are achieving those early bookings with strong demand.
In fact, pricing on our book position for the back half of 2022 improved since last quarter, and that's despite the Delta variant.
The current environment while challenging, has improved dramatically since last summer.
And as the current trend of vaccine rollout and advancements in therapies continues, it should improve even further by next summer.
So looking forward, we remain on a path to consistently deliver and slow from operations during the second quarter 2022 and generate profit in the second half of 2022.
Importantly, we believe we have the potential to generate higher EBITDA in 2023 compared to 2019, given despite our modest growth rate, additional capacity and our improved cost structure.
Throughout the pause, we have been proactively managing to resume operations as an even stronger and more efficient operating company, to maximize cash generation and to deliver double-digit return on investment.
Once we return to full operations, our cash flow will be the primary driver to return to investment grade credit over time, creating greater shareholder value, and we continue to move forward in a very positive way.
And for that, I again express my deepest appreciation to our Carnival team members, both shipboard and shoreside, who consistently go above and beyond.
I am very proud of all we've accomplished collectively to sustain our organization through these challenging time and I'm very humbled by the dedication I've seen from our teams throughout.
Of course, we couldn't have done it without the overwhelming support from all of you.
I'll start today with some color on our positive cash from operation followed by a review of guest cruise operations along with a summary of our fourth quarter cash flow, then I'll provide an update on booking trends and finish up with some insights into our financial position.
Turning to cash from operation.
I am so happy to report that our cash from operations turned positive in the month of November, ahead of our previous indication, driven by increases in customer deposits and other working capital changes.
We all know that booking trend are a leading indicator of the health of our business with solid fourth quarter booking trend leading the way, driving customer deposits higher, positive EBITDA is clearly within our site.
Over the next few months, we expect ship level cash contributions to grow as more ships return to service and as we build on our occupancy percentage.
However, cash from operations and EBITDA over the next few months will be impacted by restart related spending and dry-dock expenses as 28 ships, almost a third of our fleet will be in dry-dock during the first half of fiscal 2022.
Given all these factors combined, we expect both monthly cash from operations and monthly EBITDA to consistently turn positive during the second quarter of fiscal 2022.
So 2022 will be a tail to hear.
While we expect the net loss for the first half of 2022, it makes me feel so good to say we expect the profit for the second half of 2022.
Now let's look at guest cruise operation.
During the fourth quarter, we successfully restarted 22 ships.
During the month of December, we will restart an additional seven ships, so we will be celebrating on New Year's Eve with over two thirds of our fleet capacity in service.
Our plans call for the remainder of the fleet to restart guest cruise operations by spring, putting us in a great position for our seasonally strong summer period.
For the fourth quarter, occupancy was 58% across the ships in service and that was a 4 point improvement over the 54% we achieved last quarter during the peak summer season despite the slowdown in bookings just prior to the fourth quarter from the Delta variant.
During the fourth quarter, we carried over 850,000 guests, which was 2.5 times the number of guests we carried in the third quarter.
Our brands executed extremely well with net promoter scores continuing at elevated levels compared to pre-COVID scores.
Revenue per passenger cruise day for the fourth quarter 2021 increased 4% compared to a strong 2019 despite the current constraints on itinerary offering.
We had great growth in onboard and another per diems on both sides of the Atlantic.
Increases in bar, casino, shops, spot, and Internet led the way onboard.
Over the past two years, we have offered and our guests have chosen more and more bundled package options.
In the end, we will see the benefit of these bundled packages and onboard and other revenue as we did during the second half of 2021.
As a result of these bundled packages, the line between passenger ticket revenue and onboard revenue is blurred.
For accounting purposes, we allocate the total price paid by the guests between the two categories.
Therefore, the best way to judge our performance is by reference to our total cruise revenue metrics.
For those of you who are modeling our future results based on our planned restart schedule for fiscal 2022, available lower berth days or ALBDs as they are more commonly called, will be approximately $78 million.
By quarter, the ALBDs will be for the first quarter $14.1 million.
For the second quarter, $17.8 million.
For the third quarter, $23 million even.
And for the fourth quarter, $23.1 million.
Fuel consumption will be approximately 2.9 million metric tons.
The current blended spot price for fuel is $563 per metric ton.
I did want to point out that due to the cost of a portion of our fleet being in pause status during the first half of 2022, restart related expenses, the cost of maintaining enhanced health and safety protocols and inflation, we are projecting net cruise costs without fuel per ALBD in 2022 to be significantly higher than 2019 despite the benefit we get from the 19 smaller less efficient ships leaving the fleet.
Remember that because a portion of the fleet will be in pause status during the first half, we are spreading costs over less ALBDs.
We do anticipate that most of these costs and expenses will end with 2022 and will not reoccur in fiscal 2023.
In addition, we expect depreciation and amortization to be $2.4 billion for fiscal 2022, while net interest expense without any further refinancings is likely to be around $1.5 billion.
Next, I'll provide a summary of our fourth quarter cash flows.
During the fourth quarter 2021, our liquidity, increased by $1.6 billion to $9.4 billion at the end of the fourth quarter from $7.8 billion at the end of the third quarter.
The increase in liquidity was driven by the $2 billion senior unsecured notes we issued in October to refinance 2022 maturities.
The $360 million customer deposit increase added to the total.
This was the third consecutive quarter we saw an increase in customer deposits.
Completion of a loan we previously mentioned, supported by the Italian government, with some debt holiday principal refund payments added another $400 million.
Working capital and other items net contributed $300 million.
All these increases totaled $3.1 billion, which was somewhat offset by our cash burn of $1.5 billion.
Simply, our monthly average cash burn rate of $510 million per month times 3.
it should be noted that our monthly average cash burn rate for the fourth quarter 2021 was better than planned, driven by lower capital expenditures.
Turning to booking trends.
Our cumulative advance book position for the second half of 2022 and the first half of 2023 are at the higher end of historical ranges and at higher prices compared to 2019, with or without FCC's, but normalized for bundled packages.
This is a great achievement given pricing on bookings for 2019 sailings is a tough comparison as that was the high watermark for historical yield.
Booking volumes for the same period during the fourth quarter of 2021 were higher than the third quarter.
During the fourth quarter 2021, we significantly increased our advertising expense compared to the third quarter in anticipation of the full fleet being in operation in the spring of 2022, generating demand and allowing us to improve pricing on our book position.
However, the fourth quarter advertising expense is still significantly below our spending in the fourth quarter 2019.
Finally, I will finish up with some insights into our financial position.
What a difference a year makes except for our liquidity.
As Arnold indicated, we entered 2022 with $9.4 billion of liquidity, essentially the same liquidity level as last year, but with significantly improved cash flow generation ahead as ship operating cash flows and customer deposits continue to build.
Through our debt management efforts, we have refinanced $9 billion to date, reducing our future annual interest expense by approximately $400 million per year and extending maturities, optimizing our debt maturity profile.
With our 2022 maturities already refinanced, we do not have any financing needs for 2022.
However, we will pursue refinancings to extend maturities and reduce interest expense at the right time.
Given our long history of positive strong resilient and growing cash flows, unlike many other industries, in 2023 our focus will shift to deleveraging, driven by cash from operations.
We expect to return to investment grade credit over time, creating greater shareholder value.
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carnival corporation & plc provides fourth quarter 2021 business update.
oration & plc provides fourth quarter 2021 business update.
q4 2021 ended with $9.4 billion of liquidity.u.s. gaap net loss of $2.6 billion and adjusted net loss of $2.0 billion for q4 of 2021.
for cruise segments, revenue per passenger cruise day ("pcd") for q4 of 2021 increased approximately 4% compared to a strong 2019.
monthly average cash burn rate for q4 of 2021 was $510 million, which was better than expected.
over last few weeks, we have experienced an initial impact on bookings related to near-term sailings as a result of omicron variant.
cumulative advanced bookings for second half of 2022 and first half of 2023 are at higher end of historical ranges and at higher prices.
booking volumes for same periods during q4 of 2021 were higher than q3 of 2021.
expects a net loss for first half of 2022 and a profit for second half of 2022 on both a u.s. gaap and adjusted basis for both periods.
cash from operations turned positive in month of november.
expect consistently positive cash flow beginning in q2 of 2022 as additional ships resume guest cruise operations.
occupancy in q4 of 2021 was 58%, which was better than 54% in q3 of 2021.
expects to continue incurring incremental restart related spend.
total customer deposits increased $360 million to $3.5 billion as of november 30, 2021 from $3.1 billion as of august 31, 2021.
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These statements include management's expectations, beliefs and projections about performance and represents management's current beliefs.
There can be no assurance that management's expectations, beliefs or projections will be achieved or that actual results will not differ from expectations.
During today's call, we will provide certain performance measures that do not conform to Generally Accepted Accounting Principles.
They provide a detailed breakdown of foreign exchange and non-cash compensation expense items, as well as segment revenue and adjusted EBITDA among other important information.
For that reason, we ask that you view each slide as William and Brian comment on them.
During the first quarter, we continued to execute on our strategic plan with the goal of maximizing our near-term performance while strengthening our ability to capture an increasing amount of advertising dollars as the global recovery takes hold.
Our first quarter revenue results were in line with the guidance we previously provided and for our American segment reflected a tough comparison against our strong performance in the first three months of 2020, which was only minimally impacted by COVID-19.
We delivered consolidated revenue of $371 million, down 32% compared to the prior year, excluding China and FX.
Brian will walk you through the details of our first quarter performance following my remarks.
Looking ahead, we remain encouraged by the progress being made with regard to vaccination process and the increasing levels of mobility across many of our markets as well as the positive sentiment we are hearing among advertisers.
As expected, we are now seeing our business return to year-over-year revenue growth through the balance of the year driven by the rebound in several markets.
Most important, as a result of the strategic investments we're making in our business, we believe we are now in a stronger position to drive revenue growth as global recovery gains traction.
These investments are primarily centered strengthening our ability to monetize our growing digital platform as well as our print assets and elevate our value proposition among the broader universe of advertisers.
Specifically, we continue to expand and integrate our RADAR suite of data analytics products into our portfolios while strategically increasing our presence in the programmatic space.
We continue to deliver a greater and more valuable set of actionable insights to advertisers while emphasizing selling creative ideas targeting specific audiences.
Put another way, we are broadening our discussions with clients beyond just the locations of our outdoor footprint to the value of specific audiences we reach with these assets.
The pandemic has provided us the ability to demonstrate the usefulness of our data as consumer journeys change, agencies and brands seek to reach them in a seamless manner.
As we focus on strengthening our ability to drive revenue growth, we have also remained diligent in managing our costs and cash flow.
Brian will provide an update on our cost savings initiatives.
Now, let me provide a brief update on each of our business segments beginning with Americas.
Based on the information we have, for the second quarter, we expect Americas revenues to be between $265 million and $275 million with adjusted EBITDA margin improving sequentially from the first quarter.
Entering May, we are seeing a notable uptick in bookings as advertisers become more comfortable with the prospect for more sustained opening of the economy as the vaccination rates improve.
Based on our data, we can see that audiences are increasingly out and about with the recovery unfold, but there remains some lag between emerging mobility patterns and ad purchasing.
We primarily attribute this to the fact that some key ad categories such as amusements and restaurants remain challenged due to capacity restrictions, but we believe they will pick up as the year progresses and restrictions are lifted.
Further, while our transit business is showing some improvement, it continues to lag in the recovery process, which is weighing on our performance.
Comprised primarily of airports, this business is well positioned to benefit as travel volume increases.
Looking ahead, we are continuing to see an increase in the number and value of RFPs.
Categories showing particular strengths include beverages, insurance, and business services.
An example of the big opportunity is centered on maximizing the opening of the economy is reflected in our recently announced partnership with Resorts World Las Vegas.
In conjunction with the opening of the resort this summer and the return of convention activity, we launched three full motion digital out-of-home displays offering advertisers premium visibility on the Vegas Strip.
They include the latest in cutting edge digital signage and represent one of the largest exterior LED building displays in the U.S. delivering over 135,000 square feet of digital signage.
With regard to our technology investments, we added 14 new digital billboards in the first quarter giving us a total of more than 1,400 digital billboards across the United States.
We also continue to strengthen our RADAR platform through partnerships aimed at further improving our data analytics and measuring the impact of our assets on consumer decision making.
We have strengthened our leading audience attribution solution RADAR-Proof by partnering with Kochava, the leading real-time data solutions company for omni-channel attribution and measurement.
Our innovative combined offering helps brands better understand out-of-home advertising impact on key metrics such as user engagement, website visits, and app downloads.
This is the kind of compelling data that is enabling us to demonstrate the power of our platform in influencing consumers on the move.
We're also continuing to make notable progress in the programmatic space.
Revenue from programmatic increased year-over-year in the first quarter will be although off a small base.
Through integration with multiple SSPs, our digital out-of-home ad units are increasingly accessible to digital buyers via the same buyside platform that they utilize to spend their considerable digital budget.
And while it's still early in our programmatic expansion, the progress we're making bodes well for the future.
Turning to our business in Europe, based on the information we have today, we expect second quarter segment revenues to be between $200 million and $220 million, excluding the impact of foreign exchange.
As in the Americas, the pace of recovery varies across Europe, driven by differing rates of vaccination and variants in attitudes to the virus in different parts of the continent, but some of our European markets are picking up momentum in terms of opening up, we're also continuing to see volatility with activity differing from country to country.
In our largest market France, the French government introduces additional mobility restrictions at the end of March, following an increase in virus cases and concerns over new variants, delaying the onset of the recovery to the middle of the second quarter.
Restrictions have started to ease with all schools now open and non-essential retail due to reopen on May 19th.
Meanwhile, we are continuing to see promising signs in some of our other markets, particularly in the U.K., our second largest market, where the Phase 3 opening is well under way supported by a countrywide vaccination rate exceeding 50%.
Over the last six weeks, our U.K. business generated bookings ahead of the comparable period in 2019 as we benefit from pent-up demand among advertisers.
Our U.K. business continued to benefit from the premium locations of our roadside inventory as well as a wide spread scale and audience reach of our digital network.
I'm proud to also note that our U.K. team was recently awarded Commercial Team of the Year at the coveted Campaign Media Awards.
The judges recognized Clear Channel's outstanding performance linked to proactive programs focused on supporting advertisers through the unprecedented challenges presented by the pandemic.
Looking at the rest of Europe, other countries that are progressing well in terms of opening up include Switzerland and Spain.
As with the U.K., we're seeing advertising spend recovering in these markets as inflation rates drop and restrictions are eased.
The overall sentiment among European advertisers is very positive reflecting pent-up demand and the need to get in front of consumers.
As with the rebound we started to see in the third quarter of last year, following the easing of restrictions, which proved to be temporary, we believe the ad market will rebound again as restrictions are waived weighed in additional markets in the months ahead.
Our digital footprint continues to expand in Europe.
We added 355 digital displays in the first quarter for a total of over 16,500 screens now live.
Supporting these assets, our RADAR roll out continues to receive positive customer traction in Spain and the U.K. We're also testing radar in Sweden ahead of our launch in the current quarter with additional launches on track thereafter in France and Belgium.
We're continuing to roll out our programmatic offering in Europe.
We recently launched a branded programmatic proposition called Clear Channel LaunchPAD, which will serve as a customer gateway connecting our premium digital out-of-home inventory to SSPs and digital buying platforms, bringing out-of-home into the omni-channel buying ecosystem.
Clear Channel LaunchPAD is now live in the U.K., Switzerland, Spain, Finland and The Netherlands with plans under way to introduce it across France, Italy, Belgium and Scandinavia.
Similar to the Americas, our programmatic platform in Europe will build over time, simplifying the buying process and providing us with an important avenue to leverage our scale and technology to target new advertising partners.
So in summary, we remain committed to executing on our strategy to expand the revenue potential of our global portfolio and optimize our ability to take full advantage of the economic recovery.
We're now seeing a return to year-on-year revenue growth in the second quarter with indicators pointing to continued improvement in advertiser demand as the year progresses.
As William mentioned, as expected, the quarter has been challenging due to the impact of COVID-19 on our business as well as tough comparisons against our strong Q1 2020 performance in Americas.
However, we are beginning to see a rebound in many of our key markets.
We aren't back to 2019 levels, but it's certainly nice to see the improvement.
We are also continuing to work on reducing costs and addressing our capital structure while investing in our business so that we are in a stronger position as our business begins to benefit from the improving economic environment.
Before discussing our results, I want to remind everyone that during our GAAP results discussions, I'll also talk about results adjusted for foreign exchange, a non-GAAP measure.
We believe this provides greater compatibility when evaluating our performance.
Additionally, we have expanded our disclosure to include more detail on Americas' revenue including breaking out transit revenue.
We've also added disclosure on site lease expenses in both the Americas and Europe segments.
Moving on to the results on Slide 4.
In the first quarter, consolidated revenue decreased to 32.7% to $371 million.
Adjusting for foreign exchange revenue was down 34.8%.
If you exclude China and adjust for foreign exchange, the decline in revenue was 31.7%.
These results were in line with expectations.
Consolidated net loss in the first quarter was $333 million compared to a consolidated net loss of $289 million in Q1 of 2020.
Consolidated adjusted EBITDA was negative $33 million in Q1 of 2021 as compared to consolidated adjusted EBITDA of $51 million in Q1 of 2020.
Excluding FX, consolidated adjusted EBITDA was negative $27 million in Q1 of 2021.
The Americas segment revenue was $212 million in the first quarter of 2021, down 28.4% compared to the prior year with a decline in revenue across all of our products.
National was down approximately 33% and local down approximately 25%.
Revenue continues to be under pressure as a result of the impact of COVID-19, but also the decline was a bit higher than Q4 2020 due to the tougher year-over-year comparisons.
As I noted earlier, the Americas team delivered an exceptional quarter in Q1 of 2020 with 8.5% revenue growth over the prior year.
Direct operating and SG&A expenses were down 21.1% due in part to lower site lease expenses, which declined 22.6% to $83 million related to lower revenue and renegotiated fixed site lease expense.
Additionally, compensation costs declined due to cost savings initiatives and lower revenue.
Segment adjusted EBITDA was $64 million down 40.5% compared to the first quarter of last year with an adjusting EBITDA margin of approximately 30%.
As I just noted, we are now breaking out our transit revenue which is primarily comprised of our airports business.
Transit was down 61.5% and airports decreased 62.4% to $20 million.
Our billboard and other was down 20.7%.
Rent continues to be a bit more resilient than digital and was down 19.1% with digital down 24.2% in the first quarter of 2020.
And on to Slide 8, within transit, print declined 52.5% and digital was down 72.8%.
As a reminder, the first quarter is proportionally the smallest quarter of the year given the seasonally low level of revenue.
Europe revenue of $150 million was down 29.4% and excluding foreign exchange, revenue was down 35.2% in the first quarter.
As expected, the extension of mobility restrictions continued to delay the rebound with the largest revenue reductions occurring in France, U.K., Sweden, and Spain.
Digital revenue was down 38.9%, excluding the impact of foreign exchange.
Adjusted direct operating and SG&A expense were down 11.6% compared to the first quarter of last year, excluding the impact of foreign exchange, both direct operating expenses and SG&A expenses decreased in most countries in which we operate with the largest decrease occurring in France and U.K. and Sweden.
The largest drivers of the decline in direct operating expenses was lower site lease expense has declined 10% to $93 million after adjusting for foreign exchange.
The decline was driven by lower revenue and renegotiated site lease expense.
Additionally, SG&A expense was down due to lower compensation attributed to lower revenue, operating cost savings initiatives, and government support and wage subsidies.
Segment adjusted EBITDA was negative $62 [Phonetic] million after adjusting for foreign exchange.
This compared to negative $14 million in Q1 of 2020.
Our Europe segment consists of the businesses operated by CCI B.V. and its consolidated subsidiaries.
Accordingly, the revenue for our Europe segment is the same as the revenue for CCI B.V. Europe segment adjusted EBITDA the segment profitability metric reported in our financial statements does not include an allocation of CCI B.V.'s corporate expenses are deducted from CCI B.V.'s operating income and adjusted EBITDA.
As discussed above, Europe and CCI B.V. revenue decreased $62 million during the first quarter of 2021 compared to the same period of 2020 to $150 million.
After adjusting for a $12 million impact from movement in foreign exchange rates, Europe and CCI B.V. revenue decreased $75 million.
CCI B.V. operating loss was $100 million in the first quarter of 2021 compared to $46 million in the same period of 2020.
Let's move on to Slide 10, and a quick review of other which includes Latin America.
As a reminder the prior year results include Clear Media, which was divested in April of 2020.
Latin American revenue was $10 million in the first quarter, down $9 million compared to the same period last year due the impact of COVID-19.
Direct operating expense and SG&A from our Latin American business were $13 million, down $3 million compared to the first quarter in the prior year due in part to lower revenue and cost savings initiatives.
Latin America adjusted EBITDA was a negative $4 million.
Moving on to Slide 11 and a review of capital expenditures.
Capital expenditures totaled $18 million in the first quarter, a decline of $18 million compared to the prior year period as we continue to focus on preserving liquidity given the current operating conditions.
Additionally, capex was also lower in part due to the sale of Clear Media.
On to Slide 12, Clear Channel Outdoor's consolidated cash and cash equivalents totaled $642 million as of March 31st, 2021.
Our debt was $5.6 billion, up slightly due to the refinancing of the senior notes and cash paid for interest on the debt was $145 million during the first quarter.
Our weighted average cost of debt was 5.9% as of March 31st, 2021.
Moving on to Slide 13, as mentioned, we continue to focus on managing our cost base and strengthening our liquidity and financial flexibility.
In April 2021, we revised the Europe portion of the international restructuring plan, which we began in the third quarter of 2020 primarily in response to the impact of COVID-19.
We expect this plan to be substantially complete by the end of the first quarter of 2023, an estimate that total charges for the Europe portion of the international restructuring plan, including $10 million of charges already incurred will be in a range of approximately $51 million to $56 million.
Substantially all charges related to this plan were or are expected to be severance benefits and related costs.
We expect a Europe portion of the plan to result in a pre-tax annual cost savings in excess of $28 million.
Additionally, we continue to work on negotiating six site lease savings and have achieved $23 million in rent abatements in the first quarter on a consolidated basis.
Also, we received European governmental support and wage subsidies in response to COVID-19 of $5 million in the first quarter.
Moving on to our financial flexibility initiatives as previously announced, we successfully completed an offering of $1 billion of 7.75% senior notes due 2028.
We use the net proceeds from the offering to redeem $940 million of our 9.25% senior notes due 2024.
Additionally, last week, we entered into a second amendment to the senior secured credit agreement, extending the suspension of the springing financial covenant through December 31st of 2021 and further delaying the step down until September 30th of 2022.
Turning to Slide 14, and our guidance.
For the second quarter of 2021, Americas' segment revenue is expected to be in the range of $265 million to $275 million and adjusted EBITDA margin is expected to improve sequentially over the first quarter of 2021.
While our Europe segment revenue is expected to be in the range of $200 million to $220 million, excluding the impact of foreign exchange.
Additionally, we expect cash interest payments of $216 million in the last nine months of 2021 and $334 million throughout 2022.
We expect consolidated capital expenditures to be in the $155 million to $165 million range in 2021.
We are optimistic about our prospects and may look to accelerate capex spending as appropriate to the balance of the year commensurate with the slope of the recovery.
We anticipate our consolidated revenue in the second half of 2021 to reach nearly 90% of 2019 levels excluding China.
The recovery is led primarily by our Americas' billboard business and a number of countries in Europe including our U.K. roadside business.
Lastly, we expect ending liquidity for 2021, including unrestricted cash and availability under the company's revolving credit facilities to be approximately $425 million to $475 million, but that could vary based on timing of cash receipts, and our payments.
Looking ahead, we are encouraged by the pace of the vaccination process and the increasing levels of mobility that we're seeing across the majority of our footprint.
In turn interest among advertisers is returning and we are seeing booking activity exceeding 2019 in several U.S. and European markets which bodes well for the year ahead.
We remain focused on strategically investing in our technology including expanding our digital platform and further strengthening our data analytics and programmatic resources with the aim of maximizing the potential of our digital board.
As we elevate our ability to demonstrate the effectiveness of our assets in influencing consumer decision making and continuing to make our inventory easier to buy particularly among digital ad buyers, we will look to expand our revenue growth potential.
As we invest in our technology, we will also continue to take steps to carefully manage our costs and preserve our liquidity as we navigate the evolving macroeconomic climate and focus on driving profitable growth over the long-term.
And now let me turn over the call to the operator for the Q&A session.
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for q2, expect americas revenue to be between $265 million and $275 million.
excluding impact of movements in foreign exchange rates, expect 2021 europe revenue to be $200 million-$220 million.
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On the call today are William Eccleshare, Chief Executive Officer of Clear Channel Outdoor Holdings, Inc.; and Brian Coleman, Chief Financial Officer of Clear Channel Outdoor Holdings, Inc., who will provide an overview of the third quarter 2021 operating performance of Clear Channel Outdoor Holdings, Inc. and Clear Channel International BV.
And Scott Wells, Chief Executive Officer of Clear Channel Outdoor Americas, will participate in the Q&A portion of the call.
These statements include management's expectations, beliefs and projections about performance and represent management's current beliefs.
There can be no assurance that management's expectations, beliefs or projections will be achieved or that actual results will not differ from expectations.
During today's call, we will provide certain performance measures that do not conform to Generally Accepted Accounting Principles.
They provide a detailed breakdown of foreign exchange, segment revenue, adjusted EBITDA and adjusted corporate expenses, including the impact of share-based compensation and restructuring charges, among other important information.
For that reason, we ask that you view each slide as William and Brian comment on them.
We delivered very strong results during the third quarter and we entered the fourth quarter with continuing business momentum that we capitalized on the broad base recovery we are seeing across our markets.
Advertisers are returning to launch new campaigns and rebuild brand awareness.
This rebound, together with new advertisers discovering our medium for the first time, is driving growth in many of our markets ahead of 2019 revenue levels in both our digital and traditional assets.
Our consolidated revenue in the third quarter increased 33.3% over the prior year.
Excluding FX, consolidated revenue was $590 million, up 31.8% over the prior year.
America's revenue was $319 million, up 42.6%, in line with our guidance and 97% to 2019 revenue.
Europe revenue was $256 million, up 18.2%, which was slightly ahead of our guidance and 97% of 2019 revenue, both excluding FX.
As we have highlighted on past calls, we have a resilient business that has consistently demonstrated its ability to bounce back from macro disruptions.
We are clearly seeing this occur and we are very pleased with how our business is performing in the current quarter.
And it is with that confidence in our business and liquidity position that we've repaid the $130 million outstanding balance of the revolving credit facility.
Coming out of COVID, advertisers are embracing out-of-home as they recognize the enhanced capabilities we have built into our platform.
The power of our assets is only matched by our team of talented and dedicated people and the deep relationships they have maintained across the industry throughout the pandemic.
Given the expansion of our digital footprint and the related strategic investments in both data analytics and programmatic that we have made in our platform, advertisers are now utilizing an even stronger set of tools that will allow them to expand this relationship through highly creative addressable and measurable solutions.
We are meeting our customers where they are by building on the very best features of out-of-home and elevating what we can do for advertisers and their brands in a compelling manner.
And so, this is an exciting time for our business as we execute on our vision to expand our share of total advertising spend.
As we focus on delivering profitable growth, we also remain committed to reducing our overall indebtedness, strengthening our balance sheet and elevating our ability to benefit from the operating leverage in our model.
As part of this effort and as momentum builds in our business, we will continue to evaluate disposition opportunities in line with our strategic goals and in the best interest of our shareholders.
Now let me provide a brief update on each of our business segments, beginning with Americas.
Based on the information we have for the fourth quarter, we expect Americas revenue to be in the range of $360 million and $370 million, which is above the $345 million we reported in the 2019 comparable period, reflecting the strong momentum in our business as we close out the year.
In the current quarter, we are continuing to experience a notable uptick in demand with a strong volume of RFPs.
National is increasing over the prior year at a slightly faster rate than local.
Based on our current revenue bookings, all our small and most medium-sized markets are pacing above Q4 2019.
We still haven't fully rebounded in a few markets in California, including San Francisco, although LA, which is our largest market is now above 2019.
In our larger markets, in addition to LA, New York, Miami and Dallas are also exceeding 2019 levels, with Houston and Boston plays behind.
I would also highlight a promising rebound we are seeing in airports across the country.
We believe our success is distributed to our teams doing a better job of servicing our customer needs and matching them to the best asset types.
For example, our traditional sales team is now selling our airport inventory.
We should note at this point, inflation and supply chain issues are not materially impacting our business, but we are of course keeping an eye on macro trends on how they are playing out.
Our digital billboards business, which continues to lead the recovery, is central to our long-term growth strategy.
We deployed 17 new digital billboards in the third quarter, giving us a total of more than 1,500 digital billboards across the United States.
We are and we remain at the forefront in driving innovation in the out-of-home industry.
We've built a dynamic platform that delivers mass broadcast level reach, along with the sophisticated insights similar to the digital display platforms with the ability to target consumers on the move.
Our RADAR solutions continue scaling up and opening new opportunities, including with major CPG brands.
Recently, we were able to match individual consumer behaviors using our RADARProof attribution tool with household purchase data from an ID resolution partner, LiveRamp.
In the CPG world, this advancement matters as households, rathan than individuals, often are the decision makers in this product category.
So we can now measure the household impact of exposure to our out-of-home advertising.
For example, in separate campaigns for a snack brand, a sports beverage and new packaged food brand, we delivered household sales insights about the consumers buying these products and how out-of-home attracts new customers to these brands.
RADARProof also demonstrates the ability of out-of-home exposure tin increase the lifetime value of repeat brand purchases, a key metric for consumer packaged goods brands.
Further, through our strategic expansion into the programmatic space, we continue to see a notable uptick in brands experimenting with programmatic and we are positioned to participate in this opportunity.
For instance, these innovations are evident in our recent campaign for Twitch and Mediahub Global to promote their second annual streamable gaming event.
The campaign won best use of programmatic with digital out-of-home this year as part of Adweek's Annual Media Plan of the Year Awards.
Our commitment to technology in improving the buying process and enhancing our ability to demonstrate attribution are key drivers of performance in our Americas business.
And I believe Scott and his exceptional leadership team should be proud of their work in delivering such a strong performance as the business emerges from the pandemic.
Turning to our business in Europe, based on the information we have today, we expect fourth quarter segment revenue to be between $335 million and $350 million, which is in line with Europe's top-line performance in the fourth quarter of 2019 of $349 million.
All amounts exclude movements in FX.
Similar to the US, in Europe, we are demonstrating the resilience of our platform and its ability to rapidly return to growth.
As we've noted in the past, about two-thirds of our European revenue comes from roadside assets.
This has benefited our performance in the current environment, given that we have limited exposures in the transit sector, which has of course seen a greater impact from COVID.
This is most evident in the UK where we have continued to deliver revenue ahead of 2019.
For the last six months, UK revenue has been ahead of 2019, led by the strength of our street furniture footprint and from the benefits of both new contracts and further development and investment in digital roadside inventory.
Overall, we are continuing to benefit from pent-up demand across Europe, although orders are still coming in later than pre-COVID.
Based on current trends, our pipeline across CPG and retail, our largest verticals, is looking strong with fashion and beauty also looking healthy.
Our digital expansion is also a central part of our growth strategy in Europe.
We added 314 digital screens in the third quarter for a total of over 16,900 screens now live, including digital screens in the UK, Italy and Ireland.
And we are further elevating the value proposition of our digital footprint through the roll out of our RADAR suite of solutions, which is now gaining traction in all of our major European markets.
For example, in Spain, we are now able to target campaigns based on online behavior in addition to physical store visits and we are having significant success using the tool in the auto category where brands are able to efficiently target likely car buyers.
In addition, we recently completed the launch of our programmatic offering, LaunchPAD in Italy.
And we are now executing on our programmatic strategy across the Europe, allowing brands to connect at the right time with consumers through multiple touch points, planned real-time digital out-of-home campaigns and control exactly when, where and at what times the ads are deployed.
We are also continuing to selectively pursue contract tenders that meet our strategic objectives in multiple markets.
In Sweden, we won a seven-year contract to operate the advertising related to a public buy program in the center of Stockholm, consisting of 350 static and digital panels in prime locations, further strengthening our footprint across the city.
So in summary, we are executing at a high level across every facet of our strategic plan.
The recovery continues to gain momentum and we are seeing good progress in our business in the current quarter.
Coming out of the pandemic, we are well positioned to maximize our performance as we leverage our digital expansion and the investments we are making in our data analytics and programmatic resources, which is broadening the universe of advertisers we can pursue and strengthening our growth profile.
As William mentioned, we continued to see a strong rebound in our business as reflected in our third quarter results and outlook for the fourth quarter and we continue to manage our cost base, including negotiating rent abatements in some of the markets most affected by COVID-19, as well as strengthening our capital structure.
Moving on to the results on Slide 4.
In the third quarter, consolidated revenue increased 33.3% to $596 million.
Excluding FX, revenue was up 31.8%.
Consolidated net loss in the third quarter was $41 million compared to a consolidated net loss of $136 million in the prior year.
Adjusted EBITDA was $136 million in the third quarter, representing a substantial improvement over the prior year, which was $31 million.
Excluding FX, adjusted EBITDA was $135 million in the third quarter.
The Americas segment revenue was $319 million in the third quarter, up 42.6% compared to the prior year and in line with the guidance we previously provided in July.
Revenue was up across all of our products, most notably print billboards, digital billboards and airport displays.
Digital revenue rebounded strongly and was up 68.4% to $115 million.
National local continue to improve with both up 43%.
Direct operating and SG&A expenses were up 15.8%.
The increase is due in part to a 15.3% increase in site lease expense, driven by higher revenue combined with higher compensation cost driven by improvements in our operating performance.
This was partially offset by lower credit loss expense related to our recovery from COVID-19.
Segment-adjusted EBITDA was $139 million in the third quarter, up 96.7% compared to the prior year with segment-adjusted EBITDA margin of 43.6%, above our guidance in Q3 2019 results due to temporary savings, including site lease savings primarily related to airports as well as lower spending and a reduction in the credit loss expense.
This slide breaks out our Americas revenue into billboard and other and transit.
Billboard and other, which primarily includes revenue from billboards, street furniture, spectaculars and wallscapes, was up 37.6%.
Transit was up 82.7%, with airport display revenue up 88.7% to $43 million in the third quarter.
Airport revenue was helped by the return of airline passenger traffic and the new Port Authority of New York and New Jersey advertising and sponsorship contracts.
Digital revenue rebounded strongly in Q3 and was up 59.5% to $91 million and now accounts for 33.4% of total billboard and other revenue.
Non-digital revenue was up 28.7%.
Please note that as I comment on the percentage change from the prior year, all percentages are excluding movements in foreign exchange.
Europe revenue was $263 million in the third quarter.
Excluding movements in foreign exchange, revenue was $256 million, up 18.2% compared to the prior year, ahead of the guidance we provided in our second quarter earnings call.
As you may remember, in Q3 2020, restrictions were lifted and the business bounced back quickly, which created tougher comps than in the second quarter.
Revenue in the third quarter was up across most of our products, primarily street furniture and retail displays and in most countries.
Digital revenue was up 39.3% to $89 million, excluding FX, a strong performance driven in large part by the rebound in the UK.
Direct operating and SG&A expenses were up 6.4% compared to the third quarter of last year.
The increase was largely driven by a $13 million increase in cost related to our restructuring plan to reduce headcount.
As a reminder, costs related to our restructuring plan are not included in adjusted EBITDA.
Site lease expense declined 3.7% to $99 million, excluding FX, driven by negotiated rent abatements.
Segment adjusted EBITDA was $30 million excluding movements in foreign exchange in the third quarter as compared to negative $8 million in the prior year.
Moving on to CCIBV.
Our Europe segment consists of the businesses operated by CCIBV and its consolidated subsidiaries.
Accordingly, the revenue for our Europe segment is the same as the revenue for CCIBV.
Europe segment adjusted EBITDA, the segment profitability metric reported in our financial statements does not include an allocation of CCIBV's corporate expense that are deducted from CCIBV's operating income and adjusted EBITDA.
CCIBV revenue increased $46 million during the third quarter of 2021 compared to the same period of 2020 to $263 million.
After adjusting for a $6 million impact from movements in foreign exchange rates, CCIBV revenue increased $39 million.
CCIBV operating loss was $26 million in the third quarter of 2021 compared to $38 million in the same period of 2020.
Let's move to Slide 9 and a quick review of other, which includes Latin America.
Note, this is the first quarter that the prior year results do not include our China business.
Latin America revenue was $15 million.
Excluding movements in foreign exchange rates, it was $!
4 million in the third quarter, up $7 million compared to the same period last year.
Direct operating expense and SG&A from our Latin American business were $14 million, up $1 million compared to the third quarter in the prior year.
Latin America adjusted EBITDA rounded to zero in the third quarter.
Now, moving to Slide 10 and a review of capital expenditures.
Capital expenditures totaled $33 million in the third quarter, an increase of approximately $6 million compared to the prior year period as we ramped up our investment in our Americas business.
Now onto Slide 11.
Clear Channel Outdoors' consolidated cash and cash equivalents totaled $600 million as of September 30, 2021.
Our debt was $5.7 billion, up $166 million, due in large part to the refinancing of the CCWH senior notes in February and in June.
Cash paid for interest on debt was $52 million during the third quarter and $264 million year-to-date.
Our weighted average cost of debt was 5.5% as of September 30, 2021, 60 basis points lower than the prior year.
Additionally, as William mentioned, given our improved outlook for both our business and liquidity position, we repaid the $130 million outstanding balance under the company's revolving credit facility with cash on hand on October 26, resulting in a corresponding increase in excess availability under such revolving credit facility.
Finishing with our guidance on Slide 12.
Again, as William noted, for the fourth quarter of 2021, Americas segment revenue is expected to be in the range of between $360 million and $370 million, which is above the $345 million reported in Q4 2019.
Segment-adjusted EBITDA margin is expected to return to close to Q4 2019 levels of $42.3%.
Q4's adjusted EBITDA margin is expected to benefit from the top-line improvement, but also from one-time items including site lease savings and temporary cost savings.
Our Europe segment revenue is expected to be in the range of between $335 million and $350 million, which is in line with Europe's revenue in Q4 2019 of $349 million.
Both the guidance and Q4 2019 consolidated revenue are based on 2020 exchange rates and exclude China.
Our consolidated Q4 revenue guidance is $715 million to $740 million, which is in line with or better than our Q4 2019 consolidated revenue of $717 million.
As noted above, guidance in Q4 2019 consolidated revenue are based on 2020 exchange rates and exclude China.
Additionally, we expect cash interest payments of $123 million in the fourth quarter of 2021 and $319 million in 2022.
We expect consolidated capital expenditures to be in the $150 million to $160 million range in 2021.
Lastly, we are once again increasing our guidance for liquidity as of December 31, 2021, including unrestricted cash and availability under the company's credit facilities.
We expect liquidity of approximately $525 million to $575 million, a $50 million increase from the guidance provided in July.
This is reflective of our improved performance and our businesses.
The guidance also includes a near-term acquisition pipeline of approximately $20 million to $25 million that we could potentially close by year end that represents small selective tuck-in billboard acquisitions in the Americas.
Please keep in mind that liquidity could vary based on timing of cash receipts and/or payments at year-end.
That concludes my remarks.
As I make the transition into the new role of Executive Vice Chairman at the close of the year, and Scott moves to take over as CEO, I am confident that we will continue to build on the momentum we're seeing in our business.
We are leading the digital transformation of our industry, innovating our platform and strengthening our ability to serve a large universe of appetizers.
We're coming out of COVID with a stronger and more dynamic platform supported by an energized worldwide team focused on growth and execution.
As we continue to invest in our technology, while carefully managing our costs, we remain focused on driving profitable growth and evaluating all avenues to delever our balance sheet, including dispositions.
It's been a pleasure to have met so many of you and have to engaged in conversations with you regarding our industry, our company and the direction of the global advertising market.
You remain of course in very good hands with Scott and the management team as they continue to execute on our plan to fully surface the growth potential and intrinsic value of our assets.
And now, let me turn over the call to the operator for the Q&A session.
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clear channel outdoor holdings q3 revenue rose 33.3% to $596.4 million.
q3 revenue rose 33.3% to $596.4 million .
sees q4 revenue $715 million to $740 million.
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Overall, the third quarter reflected a continuation of our strategy of investing in our North American assets to further reposition the company with lower cost, sustainable free cash flow and solid returns over longer mine lives.
As you can see, it was a quarter with several significant developments and decisions.
Results were in line with our internal forecast and we're set up to deliver a strong finish to the year and achieve our original production guidance.
Mick will go through the operations in more detail shortly, but I'll quickly touch on a few main points.
Wharf led the pack and achieved its second highest operating cash flow and free cash flow since we acquired the operations 6.5 years ago.
Palmarejo and Kensington were largely on plan and are on track to deliver strong fourth quarters and Rochester's results reflect steady progress despite devoting 38.5 days, or about 45% of the quarter, to crushing and hauling over-liner material to the new Stage VI leach pad before winter.
It's worth pointing out that Rochester's year-to-date results reflect 2.5 months of essentially no stacking on the legacy Stage IV pad as they prioritize activities to support the POA 11 expansion.
On the exploration front, results continue to validate our ongoing commitment to these higher levels of investment.
We invested $20 million in exploration during the quarter alone.
This commitment to drilling has led to double-digit reserve and resource growth over the past few years and we look forward to hopefully delivering further growth again at the end of this year.
We anticipate investing $70 million in exploration in 2021, which is nearly 40% higher than the record we set last year and is one of the largest programs in our sector.
We remain on track to achieve our full year drill footage targets, yet investing slightly less than originally anticipated, which reflects efficiencies we are realizing from these larger programs.
We will plan to provide another exploration update before the end of the year that will focus on exciting new results at our assets in Nevada, both at Rochester and from the Crown district in Southern Nevada where there continues to be a lot of activity.
Switching over to our expansion projects, I want to walk through some updates starting with the Rochester POA 11 expansion.
This project remains our top priority and is a transformative well-funded source of production and cash flow growth for the company.
Things are moving right along.
Overall progress stood at 42% complete at the end of the third quarter.
In addition to completing the crushing of over-liner for the new Stage VI leach pad, the team also kicked off foundation work for the Merrill Crowe plant and the crusher corridor during the quarter.
As we mentioned on our last conference call, we're experiencing the impact of inflation on remaining unawarded work, like most companies are reporting.
Overall, we're fortunate to have had the vast majority of our contracts locked in prior to the current spike in costs and supply and labor disruptions.
We're trying to mitigate some of these impacts by rescoping and rebidding unawarded contracts, but we currently estimate that we're likely to see a 10% to 15% overall increase to the POA 11 construction costs.
We have kicked off detailed engineering and we'll be evaluating the merits of implementing this process improvement over the coming months.
Assuming we elect to pursue this opportunity, it could potentially extend the timetable for completion and commissioning of the crusher by three to six months.
In the meantime, we plan to install pre-screens on the existing crusher during the first half of next year to give us some full scale run time and experience that we can potentially incorporate into the new crusher configuration.
Now switching over to Silvertip.
Given the current inflationary environment and pandemic-driven supply and labor disruptions, it's not an ideal time to be kicking off a new capital project on an accelerated timetable despite multi-year high zinc and lead prices.
Fortunately, Silvertip expansion and restart is still in the early innings, which gives us a lot of flexibility.
Despite the uncertain macro-environment, which contributed to higher-than-expected capital estimates for an accelerated expansion in restart, one thing we are certain of is the quality and prospectivity of the Silvertip deposit.
The exploration results, along with the knowledge and new discoveries the team is generating, have led us in the direction of evaluating a larger Silvertip expansion and restart on a potentially slower timetable.
To take advantage of such a high-grade and significant resource, a 1,750 ton per day processing facility isn't likely large enough to maximize Silvertip's value.
We're going to take some additional time to evaluate what a larger design and footprint could represent in terms of economics and overall flexibility.
This approach will give us time to continue drilling and hopefully keep growing the resource, allow for the dust to settle on many of these current macroeconomic factors and allow us to focus on delivering POA 11 while not straining the balance sheet.
Finishing out the highlights.
We're pleased to announce that we entered into an agreement with Avino Silver & Gold to sell them the La Preciosa project in Durango, Mexico.
This transaction offers some real potential synergies to unlock value from that asset with their nearby Avino mine.
Strategically, the transaction checks a lot of boxes for us with respect to further enhancing our geopolitical risk profile, our metals mix and the timing of our development pipeline.
We can deploy some of the fixed cash consideration into the Rochester expansion and into our highly prospective exploration programs.
The transaction provides a lot of upside to the asset through the equity ownership we will have, along with contingent payments and two royalties we will retain.
Shifting gears, I want to quickly bring your attention to a set of slides starting on Slide 17 that highlight the great culture and diversity efforts we have at Coeur.
To be a high performing organization, a company's culture, strategy and capabilities need to be aligned, something that I believe we've achieved over the past few years.
To that end, I want to recognize our Head of Human Resources, Emilie Schouten, for her efforts on DE&I and for recently winning the industry's Rising Star Award from S&P Global Platts.
We continue to integrate our ESG efforts into our strategy and overall decision making.
Before having Mick provide an overview of our operations, I'd like Hans to follow-up on my Silvertip comment by providing a brief overview of the Silvertip exploration results and why we are so positive about its potential.
We bought Silvertip in late 2017 with the recognition that the asset has excellent growth potential.
We now have almost 3.5 kilometer of potential growth defined based on step-out drill holes or more than triple what we knew in 2017, as highlighted on Slide 8.
This year, we are completing the largest exploration program in the history of the project.
Impressively, Silvertip accounts for roughly 25% of our $70 million overall budget at Coeur.
The site team led by Ross Easterbrook has done an outstanding job managing the 1,000-meter drill program.
Drilling from underground has given us the ability to conduct exploration year-round and test different parts of the ore body from different angles, which has been a crucial part of the Silvertip growth story.
Underground drilling in early 2021 has led to the discovery of the Southern Silver Zone vertical feeder structures and thick manto ore zones and, more recently, vertical feeder structures under the Discovery South Zone.
These structures represent significant resource tonnage potential and demonstrate excellent upside.
We now have two rigs active underground with plans to add a third rig early next year.
We also expect to continue with three surface rigs testing resource growth to the south in the 1.5-kilometer gap between Southern Silver and Tour Ridge zones.
With the larger drill budget this year, we expect to continue significant growth at Silvertip, which will give our development team confidence to right-size the future operation to fit the potentially increased scale of the ore body.
The team reported last week they've cut the best hole ever with 11 mineralized manto horizons.
The hole is located under Silvertip Mountain about 500 meters or 1,500 feet south of the Southern Silver and Camp Creek zones in an area with no resource shapes at this time.
This new step-out hole is the significant indicator of the growth potential we expect for 2022 and beyond.
I'll now pass the call over to Mick.
Before diving into operational results, I want to recognize the team for continuing to prioritize health and safety and driving continuous improvement in this area.
Flipping to Slide 24, I'm proud to report that we recently received the NIOSH Mine Safety and Health Technology Innovation Award for our cross-functional COVID-19 response efforts.
I'm truly honored to be part of such a great team that is relentless in its efforts to work together and look after the well-being of our people.
Now turning to Slide 5 to cover the operations and starting off with Palmarejo.
The team did an excellent job maintaining higher throughput levels and maximizing recoveries to offset some of the lower grades that we've been experiencing with our resequenced mine plant.
We've also continued advancing development while focusing on increasing rehabilitation rates across the mine, which helps ensure that we've appropriately prioritized the health and safety of our workforce.
Quarterly operating costs remain within guidance helping to counterbalance lower realized prices and generate $15 million of free cash flow.
We expect a strong finish to the year at Palmarejo and we're excited to see how much production growth we can achieve here in this fourth quarter.
Switching over to Rochester.
We crushed just under 1.3 million tons of over-liner for the new Stage VI leach pad during the quarter, completing the necessary requirements for POA 11.
It's important to note, when we are generating over-liner, we were not crushing materials stacked on the legacy Stage IV leach pad, which had a knock-on effect for production during the third quarter.
Despite the near-term production impact, all-time energy and resources used to finish crushing overlay now was an important step toward completing this highly anticipated expansion project.
Now turning to Kensington.
Production was slightly higher during the quarter as better agreed [Phonetic] help to offset lower mill throughput caused by stope sequencing and drill parts availability.
The good news is that we anticipate more high grade Jualin material over the coming months and have already received the necessary spare parts for stope drills, leaving us very well positioned for strong production growth in the fourth quarter.
The Kensington team did an excellent job balancing multiple priorities and maintaining solid cost controls throughout the quarter, which helped generate nearly $15 million of free cash flow.
Finishing with Wharf, I want to start by acknowledging the tremendous achievement.
On October 3, the team at Wharf celebrated one year without a recordable safety incident, truly an amazing accomplishment.
From a results standpoint, Wharf put together yet another great quarter, which marks back to back periods of strong performance.
Gold production was up 17% and cash flow figures was the second highest since Coeur's acquisition back in 2015.
With that, I'll pass the call over to Tom.
First, I wanted to add a bit of color on the non-cash adjustments that impacted our third quarter earnings.
We wrote off $26 million of Mexican VAT refunds, to which we strongly believe we are entitled, but like many other multinational companies doing business in Mexico, we have experienced significant challenges from SAT in the Mexican courts in obtaining these payments.
We also had a mark-to-market adjustment on our equity investments, primarily related to Victoria Gold.
However, the carrying value of the investment remains above our original cost.
Turning over to Slide 4, I'll quickly run through our quarterly consolidated financial results.
Revenue of $208 million was driven by relatively stable metal sales and a lower average realized silver price versus the second quarter.
Operating cash flow totaled $22 million, which was lower than last quarter but also negatively impacted by changes in working capital.
Removing working capital, operating cash flow improved by more than 10% quarter-over-quarter.
Like most companies, we've seen cost pressures related to consumables and labor across all of our operations.
With stronger expected Q4 production, we anticipate operating cash flow levels to continue climbing as we finish out the year.
Turning over to Slide 12 and looking at the balance sheet, we ended the quarter with approximately $330 million of liquidity, including $85 million of cash and $245 million of availability under our revolving credit facility.
Also, it's worth highlighting that these numbers do not include the $140 million of equity investments on our balance sheet.
We did draw down modestly on the revolver.
We ended the period with a net debt to EBITDA leverage ratio of 1.4 times.
We will continue adhering to our disciplined capital allocation framework and remain focused on our goal of keeping net leverage below 2 times and maintaining liquidity of at least $100 million throughout the entire Rochester construction period.
However, we expect the revised timeline for Silvertip, along with the current robust metals price environment, will leave us well positioned to maintain a strong and flexible balance sheet.
I'll now pass the call back to Mitch.
Before moving to the Q&A, I want to quickly highlight Slide 13 that outlines our near-term priorities as we approach the end of the year.
With production guidance reaffirmed and a strong expected fourth quarter underway, we're feeling confident about our 2021 results and in our ability to carry this momentum into next year.
We'll continue pursuing a higher standard and execute at a high level to deliver consistent results and industry-leading organic growth from our balanced portfolio of North American-based precious metals assets.
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q3 revenue $208 million versus $229.7 million.
reaffirms production guidance; updates cost and capital expenditure guidance.
full-year 2021 capital expenditures are expected to be slightly lower at about $35 million - $40 million.
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Our results were released after yesterday's market close.
2020 was quite the year.
Obviously, COVID-19 was the main headline for everyone and of course we were no exception.
COVID had a big impact on the first half of our year by sharply driving down prices and forcing a government-mandated shutdown in Mexico, which impacted us at our Palmarejo mine.
Of course, prices have strengthened considerably since their April lows and Mexico allowed mining to resume in the second quarter.
And together with solid production and effective cost and balance sheet management, we delivered a strong second half of 2020, which Mick and Tom will talk more about shortly.
I first want to take a minute to recognize our people for how they've risen to the occasion over the past 12 months.
We've asked a lot of everyone and our entire organization has responded incredibly well to the challenges.
I can't help but have immense pride for how well our culture has served us, the talent we've attracted, the ESG leadership we've established and the overall performance we delivered during such an unprecedented year.
Now starting off on Slide 3 and 4.
There were a lot of highlights and accomplishments last year that led to adjusted EBITDA jumping over 50%, to $263 million and free cash flow climbing to $49 million.
For starters, we achieved production guidance at all of our sites and unit costs were at or below full year guidance ranges at each of our primary gold operations.
Palmarejo's results were truly remarkable, the way they ramped back up mid-year and really never looked back.
And Kensington and Wharf also had fantastic years with both operations breaking their previous free cash flow records.
Rochester finished the year much stronger than it started, with fourth quarter silver production increasing nearly 40%, and gold production up almost 50% quarter-over-quarter.
And just to add a bit more color on Rochester, the big highlight last year was kicking off the expansion and providing the details of this project late in the year.
The updated mine plan reflects a reserves-only 18-year mine life with an NPV of $634 million and an anticipated IRR of 31%.
Production rates are also expected to double, driving average free cash flow to over $100 million per year.
Until this expansion is completed late next year, Rochester will remain in a state of transition while we balance near-term performance with gathering and applying key learnings to ensure Rochester's long-term success.
During this time, we'll also remain focused on further expanding Rochester's silver and gold reserves beyond the 58% and 65% growth we saw last year.
It was the largest drilling program in our history, and it was wildly successful.
Gold reserves grew by over 20%, and silver reserves increased by over 40% to the highest levels in Company history.
We've now dramatically increased our overall average mine life from just over seven years in 2015 to well over 12 years currently.
And with over $65 million allocated to exploration this year, we expect to see this number extend out even further.
These investments in exploration rank among our most attractive capital allocation priorities and should help drive higher returns on invested capital going forward.
On top of our reserve success, we made a new discovery in Southern Nevada called C-Horst, located in the Crown district, which has the potential to become a significant asset for the Company.
We included several recent drill holes in yesterday's release from C-Horst, including one that was over 216 meters, averaging just about 1 gram per ton of oxide gold.
An aggressive drilling program has already begun at C-Horst this year.
And we plan to invest approximately $10 million to continue growing this new discovery.
Another big success from last year's exploration program was the substantial resource growth at Silvertip in British Columbia.
With only around half of the assays back at the end of the year, total resource tons increased over 40% and we more than tripled the strike length of the high-grade deposit to over 3.5 kilometers.
We plan to invest roughly $14 million in exploration at Silvertip this year, aimed at further expanding the resource and beginning to convert some of this material to reserves.
I'm sticking with Silvertip for a minute.
We ended 2020 feeling confident in the resource and in our ability to continue expanding Silvertip's mine life with further drilling.
We also have identified and expect to lock down the flow sheet for a straightforward 1,750 ton a day process plant that can reliably deliver consistent recoveries and generate high-quality concentrates.
The team is now focused on optimizing capital costs, the mine plan and operating costs to incorporate everything we learned from last year's PFS.
We're also working through how best to slot in a potential expansion and restart to maximize the likelihood of success without distracting us from our Rochester expansion.
Our goal is to end the year with a solid, compelling business case to justify a decision to move forward at silver tip.
Our three-year outlook reflects strong returns and a step change in production and cash flow.
If you didn't get a chance to listen to our Investor Day in December, I encourage you to go to our website, look at the materials or watch the replay to find out more about our culture, strategy and outlook.
Before passing the call to Mick, I want to quickly highlight Slides 18 and 19 which provide a good high-level overview of our deep-rooted community relationships.
We strive to maintain strong relations with all of our partner communities and other local stakeholders with the goal of a mutual long-term prosperity.
Wow, what a great quarter and a strong finish to the year.
Building on our momentum, we expect to deliver another strong year from our operations in 2021.
Now taking a look at Slide 6 and 7 and beginning with Palmarejo.
Strong results during the second half helped us finish the year on a high note, despite being down for roughly 45 days in the second quarter.
Full-year gold production finished above the high end of its guidance range, while silver production was in line with expectations.
Additionally, the team did an excellent job balancing operating and financial results during the year which resulted in the unit costs for both gold and silver to come in below the low end of their guidance ranges.
Together, these great accomplishments helped to generate nearly $93 million of free cash flow; Palmarejo's largest free cash flow year since 2017.
Looking at the year ahead, we plan to increase our mining and throughput rates to help offset some lower grades and expect Palmarejo to have another great year in 2021.
Turning over to Rochester.
We're going to see positive results from our revised stacking plan, which leverages inter-lift liners to maximize the placement of HPGR-crushed ore on shallower portions of the leach pad.
This strategy directly led to higher production during the second half of 2020, helping us to achieve the low end of our production guidance for both silver and gold.
Unit costs came in slightly higher than expected, largely due to additional cyanide dosing as well as higher metallurgical outside services costs for modeling the test work and the consultant support, we used to drive the improvement program in the second half.
Going forward, we are continuing to focus on performance enhancements and driving sustained improvements in our results.
Before moving on, I want to quickly highlight two important items for Rochester in 2021.
We plan to swap out the existing secondary crusher in the second quarter to further optimize gradiation of crushed material at higher throughput rates.
This will give us the opportunity to dial in the new unit before it goes into the expanded crusher corridor as part of POA 11.
We also plan to begin crushing over liner material for the new Stage VI leach pad during the second half of the year and we have solid plans for both of these projects to mitigate some of the operational impacts.
It's important to remember that we are effectively using inter-lift liners and the existing crushing circuit as a full-scale test bed to optimize performance, helping to derisk our ability to achieve the expected results from the expansion in the coming years.
Switching over to Kensington.
2020 was an excellent year for the operation.
The team's diligent focus and efforts helped us achieve our full year production and cost guidance, which led to a record $60 million of free cash flow.
We expect another strong performance from Kensington in 2021, aided by the inclusion of Eureka and Elmira into the operation's production profile.
Lastly, at Wharf, the team did a great job accomplishing their goals for the year, and achieved guidance by producing over 93,000 ounces of gold at an average cost around $890 per ounce.
More importantly, Wharf generated $73 million of free cash flow, shattering its previous record by over 25%.
Looking ahead, we plan to move some additional tons during 2021.
While this is expected to result in marginally higher costs, we anticipate Wharf will have another great free cash flow year.
With that, I'll pass the call over to Tom.
Slide 5 highlights our fantastic financial results.
As Mitch and Mick mentioned, strong performances from Palmarejo, Kensington and Wharf, along with higher realized prices led to significant improvements in our annual financial results.
Margin expansion from top line growth and prudent cost management helped us generate over $260 million in adjusted EBITDA and nearly $150 million in operating cash flow.
Both metrics were over 50% higher year over year.
These results showcase the power of our portfolio, especially during the second half of 2020 when our assets generated $86 million of free cash flow.
The strong second half more than offset the slower start to the year, leading to nearly $50 million of free cash flow in 2020, our highest annual figure since 2017.
Looking ahead, as highlighted on Slide 15, we issued our 2021 guidance consistent with our recent Investor Day outlook.
These guidance ranges signal another solid year of operating cash flow and EBITDA.
I do want to flag that we are anticipating a relatively weaker first quarter, driven by, one, our mine plans, production profile and buildup of inventories on our leach pad; secondly, timing of tax payments in Mexico combined to be roughly $30 million to $35 million of cash outflow; and third, annual incentive payouts across the Company.
Turning over to Slide 13, I wanted to emphasize a few key takeaways from our balance sheet.
We bolstered our financial flexibility during the fourth quarter by fully repaying our revolving credit facility borrowings and expanding the capacity of the revolver to $300 million.
Together with our significantly improved cash position, this led to nearly $360 million of liquidity at the end of the year.
Looking at our leverage levels, both total debt and net debt-to-EBITDA decreased steadily during 2020.
Particularly, our key leverage metric, net debt-to-EBITDA was cut in half year-over-year ending 2020 at 0.7 times.
We are targeting a net debt-to-EBITDA ratio of under 2 times, while maintaining at least $100 million of liquidity over the next two years as we complete major construction at Rochester.
By using a combination of cash on hand, operating cash flow and debt capacity, we are confident in our game plan, leaving us very well positioned to fund this phase of significant capital investment.
I'll now pass the call back to Mitch.
Slide 14 shows our top priorities for 2021.
And by following this road map, we believe we can deliver solid results over the short, medium and long term from our balanced portfolio of North American precious metals assets.
With that, let's go ahead and open it up for any questions.
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full-year 2021 capital expenditures, sustaining are expected to be about $80 million - $100 million.
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Participating in today's call will be Bruce Schanzer, Chief Executive Officer; Robin Zeigler, Chief Operating Officer; and Philip Mays, Chief Financial Officer.
These statements are subject to numerous risks and uncertainties, including those disclosed in the company's most recent Form 10-K to the year ended 2019, as updated by our subsequently filed quarterly reports on Form 10-Q and other periodic filings with the SEC.
As you all realize, this has been and continues to be a time of incredible stress, with many folks worrying about contracting a frightening virus, and managing all of the personal challenges this pandemic has engendered.
Although, we usually describe our grocery anchored shopping center assets as being resilient, I can proudly say that the members of team Cedar are most valuable assets, have proven themselves to be even more resilient than our shopping centers, as they have performed their jobs with a characteristic focus on everyday excellence, collegiality, and collaboration.
Since the outset of the pandemic, we have focused on a number of pressing matters in order for us to emerge from this period on a strong footing as possible.
First and foremost, we have endeavored to help our tenants survive the economic shutdown, and ideally pay their rents or at a minimum agree to a forbearance arrangement, whereby we have the right to collect the rent in the future.
Second, we have awaited the reopening of the real estate debt capital markets in order to arrange the refinancing of our $75 million term loan maturing in February 2021, as well as addressing our other upcoming debt maturities.
Third, we have advanced our redevelopment projects, while exploring joint venture arrangements for the initial phases, especially the recently announced DGS building.
Fourth, we have used this period to take a rigorous zero based approach to many G&A categories, and have identified substantial savings that we anticipate benefiting from not only in 2020, but more generally in 2021 and beyond when we see the full-year impact of some of these measures.
Before walking through each of these areas of focus during the pandemic, it is worth reflecting on a remarkable revelation afforded by this period.
At Cedar, we have consistently articulated a two pronged long-term business strategy that we have steadfastly pursued for many years through the ups and downs of the market and our stock price performance.
First, we have focused on a core portfolio of grocery anchored shopping centers in the D.C. to Boston corridor, and have therefore systematically divested non-core assets.
Second, we have pursued mixed use urban redevelopment projects in high population density submarkets within our D.C. to Boston footprint, with a particular focus on building affordable and market rate workforce housing at these projects.
Remarkably, the pandemic has highlighted the very trends we have anticipated and been building toward with our two pronged strategic plan.
Specifically, the accelerated secular demise in many bricks and mortar retail categories has led to grocery anchored shopping centers being the strongest performing category within retail real estate.
Notably, our grocer anchors have experienced a growth in sales during this period, and the inline tenants and junior anchors in our centers have benefited from the strong traffic and overall center vitality resulting from the strong grocer performance.
Additionally, the pandemic triggered a wave of de-urbanization from center cities and significant pressure on higher end multifamily, while highlighting the inequality of housing opportunities within our cities, and the growing need for attractive and reasonably priced workforce housing.
Thus, the particular multifamily market opportunity which we are targeting with our mixed use projects has grown deeper during this period.
Now some comments on our four primary focus areas over the last few months.
This appears to be among the better collection rates for all retail REITs in the third quarter.
Cedar's relatively high degree of success is a direct result of the tirelessness with which the team approach the challenges presented by the pandemic, as well as the aforementioned decision made when we arrived at Cedar back in 2011 to hone our portfolio to focus on a core portfolio of grocery anchored shopping centers in the D.C. to Boston corridor.
At the outset of the pandemic, we formed a cross functional committee within Cedar that engaged with all of our tenants in an effort to make sure that they endure and come out of this crisis as favorably positioned as possible.
In addition, this cross functional committee laid the groundwork for a highly detailed and analytical approach that included using legal tools, center and tenant monitoring, as well as repeated tenant outreach.
As they say, the proof is in the pudding.
And apparently our approach has proven effective as measured by our rent collections over the past two quarters.
We felt this was a prudent move since while we are comfortable that the mortgage debt markets are open and attractive, we didn't want to have to worry about the closing dragging a bit nor do we want to have to deal with the possibility of further dislocation in the capital markets, owing to a second wave in the coming winter months.
As Phil will describe, there appear to be interesting and attractive refinancing options for both the term loan, as well as our other near-term financing needs.
Third, as was announced in July, and discussed at our second quarter earnings call, we have finalized a 20-year built-to-suite office deal with DGS at our Northeast Heights project in Washington D.C.
This building will serve as an anchor for the project and also represents the first phase of the project.
We have been actively engaged with various debt and equity financing sources and are optimistic that we will be able to finalize an arrangement later this year or early next that will allow us to break ground and get started with this exciting project.
More generally, much as our strategic decision early on to focus on grocery anchored to the exclusion of other retail asset types has proven to be a good decision.
Our particular redevelopments have proven to be well positioned as we begin to hope we come out of this pandemic period.
Fourth, we have taken a zero based approach to our G&A in evaluating many corporate expenses.
A great example of how this approach has borne fruit is our decision to relocate our headquarters office from a building in Port Washington Long Island, where we rent space on a lease expiring in February of 2021 to the back of a Carman's Plaza Shopping Center in Massapequa Long Island, where we are converting a space that has been essentially unrentable during my tenure into office space, which we will occupy rent free.
Considering that our full-year rent expense is approximately $500,000, this is a terrific G&A savings opportunity.
More generally, we anticipate reducing year-over-year G&A by an excess of $2 million through the zero based cost savings approach.
In sum, we have navigated through this period of unprecedented personal and professional stress remarkably well thus far.
First, we have managed to bounce back from the initial shocks to our business with a collections level this past quarter of 91%, representing among the better performances through the third quarter among retail REITs.
Second, we've addressed our near-term debt maturities and are optimistic about closing on a permanent refinancing later this year or in early 2021.
Third, we are similarly focused on finalizing both the debt and equity financing needs of our redevelopment projects, especially the DGS building, which will position us to commence the project in early 2021.
Last, we have tightened up our overhead in the face of all distress with full-year G&A savings anticipated to be in excess of $2 million in 2021.
Our progress to this point is not an accident.
It begins with my colleagues on team Cedar, who have conducted themselves with exceptional resilience and professionalism during this time of great stress.
They are supported by decisions we have made many years ago to focus strategically on grocery anchored shopping centers in the D.C. to Boston corridor, and on urban mixed use projects with an affordable or market rate workforce housing component.
In the coming months and quarters, we look forward to announcing continued progress on all these endeavors, while we hope that there is no second wave, and that this terrible pandemic recedes into the rearview mirror.
With that, I give you Robin to provide greater detail on many of these topics.
Not only are we living in unprecedented times, but we are operating shopping centers in unprecedented times as well.
While our team has been focused on working with tenants through deferral negotiations and the collections process, we are also laser focused on what happens on the other side of this pandemic.
What do our tenants need from their landlord to maximize their ability to survive this pandemic?
How can we help our tenants pursue omnichannel operating measures to hedge their risk and pivot into a new operating environment?
What cost savings measures can we put into place that help both the tenants and the landlord from a CAM and capital expenditures standpoint.
These are among the topics we are addressing as we deliberately, thoughtfully and strategically advance our operations.
The professionalism of our team has been exemplary as they deal with not only ordinary course business challenges of daily operations, but astutely balancing those with the video conferences, field visits, and the ongoing impact from social unrest in some of our urban markets.
Our centers remained open during the third quarter with 96% of our tenants opened for business.
The users that have not reopened are mainly movie theatres, fitness and buffet style restaurants.
We have had another successful quarter of rent collections reaching our highest yet collection rates since the inception of COVID of 91%.
Moreover, October collections are currently at 91%, which does not reflect one high credit anchor that pays at the end of the month, which will take us to approximately 92.5% for October.
In order to ensure tenant health and occupancy, we have actively engaged with almost all of our over 800 tenants during the pandemic.
We completed 105 deferral and waiver agreements through September 30, 2020, totaling $3 million of deferred rent with a required payback beginning over a period ranging between July 2020 and March 2021.
The number of months differed averages four months for an average payback period of 10 months.
$900,000 of rent was waived as of September 30, 2020, for an average of four months.
These agreements were made with tenants in an effort to not only sustain their viability, but also to achieve some landlord favorable concessions including sales reporting, additional lease term and modification of key lease provisions.
Despite the pandemic our leasing momentum remained strong.
32 leases were signed this quarter, eight new deals totaling 72,800 square feet, and 24 renewals totaling 167,300 square feet.
The new deals executed were at a positive spread of 21.5% and include two anchor deal Shoppers Road at Jordan Lane [Phonetic] at a spread of 44% and America Sprayed at Golden Triangle [Phonetic] at a spread of 23%.
The renewals were done at a negative spread of 3.1% when analyzed in total.
The negative spread is a result of anchor and junior anchor renewals with home goods at New London mall, Goodwill at Groton and Yes!
Organic at Shoppes at Arts District, which were done with the objective of retaining these important anchor and junior anchor occupancies and missed the pandemic.
The spread increases to positive 2.8% excluding these three tenants.
As of September 30, 2020 our current lease same center occupancy is 91.7%, a 0.2% increase from prior quarter.
We continue to have momentum on our redevelopments and value add renovations.
At Fishtown crossing Starbucks had their grand opening in September, GameStop and T-Mobile have relocated, Nifty Fifty was delivered in August, and the original Hot Dog Factory was delivered in September.
We expect the IGA grocery store facade renovation to be completed by the end of the year and the remaining facade renovation for the rest of the center to be completed in 2021.
Also in Philadelphia, we are making progress on site plan amendments to our Revelry project.
Our original site plan was based on a movie theatre anchor.
Since the pandemic shutdowns, United Artists Cinema at Revelry has not yet reopened.
We are in discussions with the potential replacement anchor tenant for this project, and we expect to regain possession of the theatre space effective in November 2020 incident to the termination of their tenancy.
We think that the potential alternate anchor will be a great catalyst for the Revelry redevelopment.
Northeast Heights continues to progress at a steady pace as well.
We contunue last -- I'm sorry, we announced last quarter that our lease was executed with the District of Columbia for a 260,000 square foot office building, including ground floor retail for the Department of General Services.
This government agency comprises more than 700 skilled professional employees with expertise in the areas of construction, building management and maintenance, portfolio management, sustainability and security at district owned properties.
This office building is slated to be built as part of the first phase of Northeast Heights.
The DGS lease structure includes a 20-year 10-month term based on a net rent of $22.52 per square foot and a gross rent of $56.43 per square foot, which includes a TI amortization of $14.09 per square foot.
Plans are under way to commence construction in early 2021.
The DGS building is a central element of Cedar's vision to realize a true metamorphosis for Ward 7 and is emblematic of the type of neighborhood we are endeavoring to create with Northeast Heights.
As always, our team remains focused and motivated to continue to create value even during these unprecedented time.
With that, I will give you Phil.
Today we announced sequential quarterly improvements in both FFO and same property NOI.
FFO increased to $8 million or $0.09 per share, compared to $5.7 million or $0.06 per share reported for the previous quarter.
Same property NOI decreased 9.1% over the comparable period in 2019, and marked improvement from the 14.6% decrease we reported in the previous quarter.
Both of these improvements were driven by our strong cash collections that Bruce and Robin discussed.
Last quarter, I walked through our cash collections and revenue recognition in a fair amount of detail and received comments that was very helpful in understanding our results.
Accordingly, I want to take a minute to once again walk through our revenue recognition in detail.
Our total tenant billings for base rent and recoveries combined for this quarter were $31.6 million.
During the quarter, we collected and recognized as revenue $30.1 million or 91% of these billings.
Additionally, we recognized another $1.1 million or 3% as revenue that we determined to be collectible, the majority of which is covered by signed deferral agreements.
Accordingly for this quarter, we recognize as revenue 94% of our build rent and recoveries for the quarter.
The $1.9 million or 6%, that we did not recognize consists of $1.8 million that was not paid by tenants, and which we have determined at this time should be accounted for on a cash basis, and $100,000 that we agreed to waive.
As reminder, just because we have placed certain tenants on the cash basis it does not mean we will not collect anything from them.
While some cash basis tenants may fail, we expect some will simply make inconsistent payments or partial payments, which we will recognize as revenue if and when received.
Moving to the balance sheet.
On our prior quarter call, we discussed that we were exploring secured debt to refinance our $75 million term loan that was scheduled to mature in February of 2021.
As the secured financing market has opened for pressured anchored shopping centers with high cash collection rates, we have engaged with two financial institutions to assist with placing secured debt.
We are working diligently toward closing secured loans in amount equal to or greater than $75 million in early 2021.
To that end, earlier this week, we utilized our revolving credit facility and retired the $75 million term loan scheduled to mature in February of 2021.
Our revolving credit facility matures in September of 2021 and has a one year extension option.
Accordingly, as Bruce noted, this provides us with flexibility concerning the timing of closing these secured loans.
And they've been a second wave of COVID should again temporarily dislocate the capital markets.
Another note worth the balance sheet matters, receivable we now have for deferral agreements.
As Robin noted, we have signed deferral agreements for $3 million, of which approximately $250,000 was repaid this quarter, and $250,000 relates to the remainder of the year, resulting in us carrying a $2.5 million receivable for deferral agreements at the end of this quarter.
The vast majority of this receivable is scheduled to be repaid in 2021, with approximately $700,000 in each Q1 and Q2 of 2021, and approximately $500,000 in each Q3 and Q4 of 2021.
The collection of these amounts will increase our cash flows from operations in 2021, but will not impact earnings as they've already been recognized.
This reverse split will not only assist with maintaining compliance with the New York Stock Exchange listing requirements, but will also reset our share price above the $5 minimum requirement of some investment funds and do so while keeping more than 10 million shares outstanding to assist with trading liquidity.
With that, I'll open the call to questions.
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q3 operating ffo per share $0.09.
qtrly same-property noi decreased 9.1% compared to a 14.6% decrease in prior quarter.
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We're really pleased to have you join us.
Then we'll be happy to take questions.
Brendan Coughlin, Head of Consumer Banking; and Don McCree, Head of Commercial Banking, are here also to provide color.
We also use non-GAAP financial measures, so it's important to review our GAAP results on page 3 and use the information about these measures and their reconciliation to GAAP in the appendix.
And with that, I'll hand it over to Bruce.
The second quarter post unprecedented challenges given the impacts from the coronavirus and widespread disruption to people's lives and the economy.
Once again, I am pleased that Citizens is rising to the occasion and delivering well for all stakeholders.
We are taking great care of customers and colleagues while posting strong results that demonstrate the diversification and resilience of our business model.
We also announced further commitments to diversity and inclusion along with initiatives to promote racial equity and social justice.
Our financial performance in the second quarter featured tremendous revenue generation and strong profitability in our Mortgage business.
We made an important investment in acquiring Franklin American Mortgage Company in May 2018 in order to gain scale and diversify origination channels in the business.
In addition, we've made investments in talent, customer experience and in digitizing and streamlining the business, which has positioned us well to capture the market opportunities we've seen since the middle of last year.
These strong results have been a ballast to windward during the low rate environment and disruptions arising from the pandemic.
Overall, our fees were up 28% year-on-year and 19% sequential quarter.
With stable net interest income, total revenue was up 7% year-on-year and 6% sequential quarter.
We did a good job on expenses, which resulted in 5.9% positive operating leverage year-on-year, up 54.9% underlying efficiency ratio and PPNR growth of 15% year-on-year.
[Indecipherable] charge-offs as our credit cost in Q2 we had a record quarterly earnings of $1.14.
As expected, however we again built our credit reserves under CECL given the deterioration in the macroeconomic conditions since the close of the first quarter.
Our ACL to loans ratio is now 2.01% and that's 2.09% excluding PPP loans.
In addition, we are selling a long-duration student loan portfolio, which freed up additional reserves for reallocation.
We feel we had good coverage now with the credit risk in both the Consumer and Commercial portfolios, though uncertainty on the path of economic recovery remains.
The strong PPNR generation and reduction in commercial line draws during the quarter helped improve our CET1 ratio to 9.6%, which is up from 9.4% in the first quarter.
We had a very liquid balance sheet during the quarter with average deposit growth of 12% sequential quarter, 8% spot.
Our spot LDR at quarter-end was 87.5% or 84.5% excluding PPP loans.
So overall, we have a very strong capital, liquidity and funding position that allows us to use our balance sheet in support of our customers.
We continue to track low on all of our key strategic initiatives for 2020 and we've been working on refreshing our strategy to incorporate key trends and learnings from the crisis.
We aim to take advantage of some of the opportunities we see to come out of the crisis well-positioned for future growth.
Now, I hope you and your families are coping with the current challenges and remain healthy and safe.
Let's start with a brief overview of our headlines for the quarter.
As Bruce said, this is an outstanding quarter for Citizens against a difficult operating backdrop.
This allows us to head into the second half of the year with good momentum and excellent balance sheet strength.
The resilience of the franchises is on display as we generated $0.55 of earnings per share on an underlying basis.
This was driven by record revenues in fee income given record mortgage fees, which offset headwinds in several other fee categories.
Net interest income was stable linked quarter given strong loan growth which offset a 22 basis point decline in margin.
This was driven by lower rates and higher cash balances that we did well in cutting deposit costs in half.
We increased our allowance for credit losses to $2.5 billion, which translates to an ACL coverage ratio of 2.09% ex PPP, up from 1.73% last quarter.
We showed excellent balance sheet strength and in the quarter with a stronger CET1 ratio of 9.6%, up 20 basis points linked quarter.
Our liquidity ratio has also improved as we ended the quarter with an LDR of 84% excluding PPP loans and we remain in compliance with the LCR.
Also, our tangible book value per share is over $32 at quarter end, up 4% compared with a year ago.
Now, let me move to the highlights of our underlying results covered on pages 4 and 5.
Even in the midst of THE COVID-19 pandemic and another strong reserve build, our results highlight the resilience of our diversified business model.
Our earnings per share of $0.55 was down $0.41 year-over-year but up $0.46 linked quarter.
PPNR of $790 million was a record, up 15% year-over-year and 17% linked quarter.
And in addition to another exceptional performance in mortgage banking, we also saw strong underlying performance and IRP and improvement in capital markets results.
Average loan growth was 6% in the quarter, reflecting PPP lending and the impact of the commercial line draws we saw last quarter, which benefited NII and helped offset the impact of the more challenging rate environment.
If we adjust for the sales, PPP and line draws, average loans were up 1% linked quarter.
Moving to page 6, I'll cover net interest income, which are quite well despite a lower margin.
Net interest income was stable linked quarter as the benefit of 8% interest earning asset growth and improved funding costs was offset by the impact of lower rates.
Net interest margin decreased 22 basis points linked quarter as the impact of lower rates and higher cash balances was partially offset by lower deposit costs and outsized growth in DDA and other lower cost deposits.
About 6 basis points of the margin decline related to higher cash balances in the quarter given strong deposit flows as consumers and small businesses benefited from government stimulus and corporate clients built liquidity.
We were especially pleased with our progress on deposit cost, which we drove down 37 basis points during the quarter, a more than 50% decline.
Our total interest-bearing deposit cost was 48 basis points at the end of the quarter.
That compares to 34 basis points back in 3Q 2015 at the end of the last [Indecipherable] period.
So clearly we have a near-term opportunity to continue to reduce these costs.
Moving to page 7, I'll discuss fees, which really shows the benefit from the work we've done to build capabilities and diversify our business.
Noninterest income was a record, up 19% on a linked quarter basis and 28% year-over-year.
Record results in mortgage banking were partially offset by continued headwinds related to COVID-19 and other fee categories.
On a sequential basis mortgage banking fees increased by 74% to $276 million reflecting continued strong refi lock volumes and record high gain on sale margins in particular.
Capital market fees of $61 million, increased $18 million from first quarter reflecting strong DCM activity and a $13 million mark-to-market recovery on loan trading assets.
Foreign exchange and interest rate product revenues increased 5% linked quarter before the impact of CVA.
Interest rate product sales led the way as clients repositioned for a lower rate environment.
CVA improvement was $8 million in the quarter.
Trust and investment services fees were lower by $8 million linked quarter given the rate environment and the effect of the equity market decline on managed money revenue.
The service charges and card fee categories were down significantly compared to first quarter reflecting the full quarter impact of the shutdown and impacts from stimulus money to customers.
On a positive note, we see debit card activity roughly back to pre-pandemic level and credit card activity in June only down about 10% compared with last year, a significant improvement from the over 30% declines we saw in early April.
Turning to page 8, underlying non-interest expense declined 2% linked quarter largely driven by seasonal impacts in Q1 on salaries and employee benefits.
Salaries and employee benefits declined $30 million or 6% linked quarter largely reflecting seasonally lower payroll taxes.
Equipment and software expense and outside services were higher linked quarter and reflect increased technology spend and investments in growth initiatives.
Next, let's discuss loan trends on page 9.
Average core loans were up 7% linked quarter primarily driven by the full quarter impact of the commercial line draws at the end of the first quarter and the $4.7 billion of PPP lending to our small business customers.
Before the impact of loan sales, line draws and PPP loans, core commercial loan growth was up approximately 1% linked quarter.
The $7.2 billion of post-COVID commercial line draws in March have been substantially repaid, and were down to $1.8 billion by the end of the second quarter.
Overall utilization is down to approximately 40% from 50% at the end of the first quarter.
Core retail loans on a linked quarter basis were stable with growth in education and other retail offset by lower home equity balances and the transfer of approximately $900 million of education loans held for sale.
We are building an originate-to-distribute model for our consumer assets, which will generate fee revenue and increase our balance sheet flexibility over time.
Moving to page 10, deposit growth was exceptionally strong in the quarter.
We saw robust average deposit growth of 12% linked quarter and 15 % year-over-year, outpacing loan growth and driving our average LDR down to 89% excluding PPP as consumers and small businesses benefited from government stimulus and clients built liquidity.
These strong deposit flows came in lower cost categories with average DDA growth up 25% on a linked quarter basis and 33% year-over-year.
We continue to aggressively execute our deposit playbook to manage down our deposit costs across all channels.
We were able to cut our interest-bearing deposit costs by roughly half this quarter, down 46 basis points to 48 basis points, and down 82 basis points year-over-year.
Let's move to page 11 and cover credit.
We continue to assess the impact of the COVID-19 pandemic and are closely monitoring the portfolio for areas of potential risk.
That said, portfolio performance is progressing largely in line with our expectations but with a somewhat more adverse macro backdrop than we saw at the end of the first quarter.
Net charge-offs were stable at 46 basis points linked quarter as increases in commercial were partially offset by improvement in retail reflecting the impact of forbearance.
Non-performing loans increased 27% linked quarter driven by $192 million increase in commercial, reflecting COVID lockdown impacts and an $18 million increase in retail.
The non-performing loan ratio of 79 basis point increased 18 basis point linked quarter and 17 basis points year-over-year.
However, in spite of this increase the non-accrual coverage ratio remained strong at 255% at June 30.
We increased our CECL credit reserve coverage ratio from 1.73% in 1Q to 2.09% in 2Q excluding the PPP loans.
This 46 basis points increase was primarily driven by a net reserve build of $317 million.
In addition, approximately $100 million of reserves associated with a planned sale of student loans were reallocated to the remaining loan portfolio.
In effect the reserve build was $417 million or 99% of the Q1 build.
On page 12, we provide detail on customer forbearance and the PPP lending program.
We continue to work directly with our customers to assist them through these challenging times and have seen encouraging trends.
The average FICO score of our retail forbearance customers remains high at 725.
And approximately 93% of these loans were current when they entered forbearance.
We also continue to work proactively with our commercial clients, [Indecipherable] needed in the form of covenant modifications will offer PPP applications as well as granting selected temporary release on principal and interest payments.
I'm also pleased to say that through June 30, our customers received $4.7 billion in PPP loans, which has allowed us to help support over 540,000 jobs.
84% of loans made were below $100,000.
Moving to page 13 to discuss our CECL methodology and reserves; we have summarized the key aspects of our macroeconomic scenario, which is a foundational element of the CECL reserve estimate.
At quarter end, we elected to use the May 13th Moody's Baseline as our base scenario.
Similar to last quarter, given the uncertainty of the continued economic outlook, we also considered other Moody's and internal scenarios.
In general, our aggregate economic scenario is more severe than that used in 1Q.
It assumes the steep drop in GDP in 2Q, is followed by a gradual recovery in the second half of the year and into 2021.
If this scenario plays out, provision requirements over the second half of 2020 should be more reflective of net loan growth and incorporate a smaller build.
However, if the pandemic impacts are deeper or it takes longer for the economy to recover, or government programs are less effective than we expect, then we could require further additions to reserve levels.
On page 14, as I mentioned earlier, we feel well positioned to manage through the current environment with strong capital and liquidity positions.
Our CET1 ratio improved to 9.6%, up 20 basis points linked quarter given our strong results and a reduction in risk-weighted assets.
Additionally, during the quarter, we issued 400 million of Q1 qualifying preferred stocks, which in combination with the increase in CET1 drove a 40 basis point increase in Tier 1 capital.
Strong deposit growth outpaced loan growth, which improved our liquidity metrics and drove the spot LDR excluding PPP loans down to 84%.
Turning to page 15, let's look at reserves and capital versus stress losses.
Our ACL of $2.5 billion represents a very strong 52%% of our modeled losses using the Fed scenario and is now 38% of the stress losses in the Fed's 2020 DFAST. In addition, when adding excess capital above our preliminary SCB of $3.4 billion to our ACL, the resulting $5.9 billion is 120% of our estimate and 88% of the Fed loss estimates.
These levels are further fortified by the additional coverage from the PPNR we regenerate.
On average, we've generated approximately 35 basis points of CET1 capacity per quarter over the last six quarters.
On page 16, we show a summary of the Fed's stress test results.
The Fed estimated our PPNR at 2.3% of average assets, which is well below the peer median of 3.3%.
We believe this ignores the steady and significant progress we have made to improve our PPNR since the IPO.
For example, our PPNR to assets for 2019 has improved by approximately 37% since the IPO to 3.7%.
Importantly, this compares to a stable 3.7% in actual PPNR to assets during the first six months realized stress in 2020.
The Fed's estimate of our credit losses at 5.6% was right on top of the peer median and down from 6.1% in 2018.
However, our estimated company run severely adverse credit loss rate of 4.2% is significantly lower.
We believe that the Fed's modeled results and the 3.4% preliminary SCB is elevated above what our business model would imply.
As such and as we indicated in our CCAR release in June, we have submitted a request to the Fed to reconsider our preliminary SCB.
On page 17, I want to highlight some exciting things that are happening across the company.
While we are first and foremost focused on helping our clients, we're looking forward and continue to work toward building a better company.
We continue to execute on the transformational TOP program and are making steady progress toward our target.
Planning is under way to add significant new transformation initiatives, including the end-to-end digitization of customer interactions and operations, as well as other initiatives to adapt to the post-COVID-19 environment.
We are also moving forward with our major strategic revenue initiatives while considering new opportunities arising from the current environment in an effort to drive higher revenue growth coming out of the crisis.
Moving to page 18, we provide some commentary on how key categories are shaping up for full year 2020 compared to the prior year.
We expect net interest income to be broadly stable as loan growth is offset by a meaningful decrease in NIM due to lower rates.
Non-interest income is expected to be meaningfully driven by the exceptionally strong results in mortgage, which more than offset the weakness in other key categories related to COVID-19.
We expect several key fee categories to benefit from a return to more normal activity levels in the second half, which will help cushion in moderation in mortgage.
Non-interest expense is expected to be up modestly particularly given higher compensation tied to stronger mortgage production and impacts from COVID-19, which includes government lending programs and customer relief efforts.
Provision expense has the greatest potential for variability and remains dependent on the path of the recovery.
We expect solid loan growth driven by the impact of higher line draws in commercial during the first half and government programs like PPP as well as increased demand in education and merchant financing.
Our capital position remains robust with our regulatory capital ratios expected to improve further over the remainder of the year driven by net income growth, a moderation in RWA growth during the second half, and the suspension of our buybacks through year-end.
Looking forward, we expect to remain well-capitalized and feel confident we can continue to maintain the dividend at the current model.
Now, let's move to page 19 for some high-level commentary on the third quarter.
We expect NII to be up modestly reflecting PPP benefit on NIM.
Excluding PPP loans, loan growth is projected to be down modestly due to the full quarter impact of a decline in commercial loan line utilization in the second quarter.
Ex-PPP, the NIM is expected to be broadly stable with the benefit of lower deposit costs being offset by ongoing rate headwinds.
Fee income is expected to be down in the mid- to high-single-digit range, reflecting lower mortgage banking fees from record levels, partially offset by recovery in other fee categories.
Non-interest expense is expected to be up in the low-single-digit range, reflecting higher origination-related cost levels in the mortgage business.
We currently expect a small reserve build, but provision expense will be highly dependent on an updated view of the economic recovery and portfolio performance.
Finally, we expect average loans to be down in the low-single digits given the paydown in commercial line draws during the second quarter.
Excluding the impact of line draws, PPP and loan sales, we expect loan growth to be broadly stable.
To sum up, our profitability, capital, and liquidity position remain strong and we are delivering well on our key initiatives for stakeholders.
Operator, let's open it up for Q&A.
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cecl-related reserve build of $317 million, or $0.59 per share, tied to covid-19 impacts.
second quarter 2020 include revenue of $1.7 billion, up 7%.
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Brendan Coughlin, Head of Consumer Banking; and Don McCree, Head of Commercial Banking are also here to provide additional color.
We also reference non-GAAP financial measures.
With that, I will hand over to Bruce.
We are pleased with the financial performance that we delivered for the fourth quarter and for the full year as we proved adaptable and resilient given the unprecedented challenges of 2020.
We continue to demonstrate the diversification and resilience of our business model as our Mortgage and Capital Markets businesses delivered strong fourth quarter performance.
We remained highly focused on taking care of customers with our retail branches opened and our teams working on the next round of PPP loans.
We feel we're managing our risk well and we continue to make progress on our strategic initiatives, which will position us well for future growth and for franchise value.
I'll comment briefly on a few of the financial headlines and then I'll let John take you through the details.
Our underlying Q4 earnings per share was $1.04, our ROTCE was 12.9%.
Both are up from a year ago quarter, and we delivered 2% operating leverage year-on-year.
Note that the full-year operating leverage was 4% and our PPNR growth was 12%.
Q4 credit provision was $124 million versus $110 million a year ago on a pre-CECL basis as the normalization of provision to more front book origination levels helped drive our strong returns.
On the capital front, we maintained a strong ACL ratio of 2.24%, ex-PPP loans and our CET1 ratio was 10%.
This strong capital and reserve position gives us a great deal of capital management flexibility in 2021.
We announced a $750 million share purchase authorization today and we will commence activity during the quarter.
We also will look to put our capital and ample liquidity position to work in finding attractive opportunities for loan growth.
Our credit metrics all are trending favorable with NCOs, NPAs and criticized assets all lower in the quarter and a further drop in customers in forbearance.
We continue to allocate additional reserves to the industry segments most affected by the pandemic and lockdowns and we feel that our coverage overall is very strong.
With respect to our guidance for 2021, we assume a steadily improving economy and GDP growth of around 5%.
Relative to current consensus, we see slightly higher revenue, expenses and PPNR as well as much better performance on credit.
We see NCOs at 50 basis points to 65 basis points for 2021 which is relative to 56 basis points in 2020.
Provision will be less than charge-offs, so how big the reserve release will be is dependent on the path of economic recovery.
Big picture, we will transition to slightly lower PPNR in 2021 given our outperformance in mortgage in 2020, but this will be more than made up for by lower credit costs, as our earnings and returns bounce back toward pre-COVID levels.
So all in all, a very strong year of execution and delivery for all stakeholders by Citizens in 2020 and we feel we are well positioned to do well in 2021 and continue our journey toward becoming a top performing bank.
We know we can count on you again in the new year.
Let's start with a brief overview of our headlines for the quarter.
This was an outstanding quarter for Citizens with strong fee income, good expense discipline and prudent credit and continued steady execution against our strategic initiatives.
For the full year, we delivered record underlying PPNR, up 12% against the challenging backdrop, driven by record fee income, up 24% with record results across mortgage, capital markets and wealth.
We achieved the ambitious TOP6 goal to deliver approximately $225 million of run rate expense savings, including approximately $140 million of in year benefits which supported our ongoing investments in strategic initiatives and financial performance targets.
To this end, we improved our efficiency ratio over 200 basis points to 56% by delivering 4% positive operating leverage for the year.
We expect further expense benefit of approximately $205 million to $225 million in 2021, which puts the program on track to deliver our total pre-tax run-rate benefit of $400 million to $425 million by the end of 2021.
Strong loan growth of around 6% reflects increased demand in education and point-of-sale financing as well as PPP loans.
Average deposits grew even faster at 13%, a result of government stimulus impact on consumers and commercial clients building liquidity.
ROTCE for the full year was 7.5%, which includes a negative 5.4% impact associated with our reserve build under CECL.
Our ACL at year-end 2020 more than doubled compared with last year, but our year-end CET1 ratio of 10% was unchanged on the year.
Strong PPNR funded the ACL bill 6% loan growth and stable dividends.
And finally, our tangible book value per share was $32.72 at quarter end, up 2% compared with a year ago.
Next, I'll refer to just a couple of slides and give you some key takeaways for the fourth quarter and then outline our outlook for 2021 and the first quarter.
We reported underlying net income of $480 million, earnings per share of $1.04 and revenue of $1.7 billion.
Our underlying ROTCE was 12.9%, up around 400 basis points as a result of our strong revenue performance, expense discipline and improvements in credit as the economy recovers.
Net interest income on Slide 6 was down only 1% linked quarter due to lower commercial loan balances and lower NIM.
However, despite the challenging rate backdrop, our margin held up well with the 8 basis point decline in linked quarter, driven by 9 basis point impact from elevated cash balances and strong deposit flows.
Lower asset yields were offset by our improved funding mix as we grew low-cost deposits with DDA up 4% and we continue to lower interest bearing deposit costs down 8 basis points to 27 basis points.
Given the recent stimulus, we expect continued strong deposit flows in the first quarter.
So elevated cash will continue to impact margin in the near term.
We will remain proactive in pricing down deposits and pursuing attractive loan growth opportunities in areas like point-of-sale finance and education as well as in attractive commercial segments.
On Slide 7 and 8, we delivered solid fee results again this quarter reflecting our ongoing efforts to invest in and diversify our revenue streams.
Mortgage fees were down approximately 30% this quarter due to declines in margins and volumes from exceptional levels last quarter.
However, mortgage fees were nevertheless more than double the levels from a year ago, which continues to provide good revenue diversification benefit in this low rate environment.
Capital market fees hit record levels, up 52% linked quarter and 33% year-on-year, driven by strong results from M&A advisory and accelerating activity in loan syndications.
Foreign exchange and interest rate products revenue is also strong, up 30% linked-quarter with higher customer activity levels tied to increased variable rate loan originations.
We delivered positive operating leverage of 2% year-over-year and improved our efficiency ratio to 56.8% as expenses were well controlled.
Average core loans on Slide 10 were down 1% linked quarter reflecting commercial payoffs and decline in loan yields -- line utilization to about 32% versus a historical average of roughly 37%.
This was partially offset by growth in retail and in our education mortgage and point-of-sale finance portfolios.
Looking at year-over-year trends core loans were up approximately 4% due to PPP education and mortgage.
On Slide 11 deposit flows have been elevated especially in low-cost categories and our liquidity ratios remained strong.
Average deposits were up 3% linked quarter and 16% year-over-year as consumers and small businesses benefited from government stimulus and clients built liquidity.
We are very pleased with our progress on deposit costs, which declined 24% or 6 basis points to 19 basis points during the quarter.
Interest-bearing deposit costs were down 8 basis points to 27 basis points.
We continue to drive a shift toward lower-cost categories with average DDA growth of 4% on a linked quarter basis and 42% year-over-year.
We expect to drive interest bearing deposit costs down to the low to mid-teens by the end of the year as we execute our deposit playbook to manage costs down across all channels, while improving our overall funding mix.
Moving on to credit on Slide 12.
Our metrics were positive this quarter.
Net charge-offs were down 9 basis points to 61 basis points linked quarter.
This is at the lower end of our guidance given better than expected improvement in commercial.
Commercial charge-offs this quarter primarily from segments most impacted by COVID-19 such as retail, casual dining and energy.
Nonaccrual loans decreased 20% linked quarter with a $302 million decrease in commercial driven by charge offs, returns to accrual and repayment activity.
In addition, our commercial criticized loans decreased 18% from $5.7 billion in 3Q to $4.6 billion in 4Q.
Given the performance of the portfolio and improvement in the macroeconomic outlook, our reserves came down slightly, but remain robust ending the quarter at 2.24% excluding PPP loans compared with 2.29% at the end of the third quarter.
This primarily reflects net charge-offs exceeding reserving needs for new loan originations.
We have some detailed credit slides in the appendix for your reference.
But I'll note that our reserve coverage for commercial excluding PPP was 2.5% at the end of the year, slightly up from the third quarter.
And within that our coverage for identified sectors of concern increased to a prudent 8.2% at the end of the year from 7.7% at the end of the third quarter.
The benefit to reserves from an improving macroeconomic backdrop offset qualitative overlays and further built reserves on these areas of concern.
We maintained excellent balance sheet strength as shown on Slide 13.
Increasing our CET1 ratio from 9.8% in 3Q to 10% at the end of the year, which is at the top of our target operating range.
Given positive credit trends in capital strength, our Board of Directors has authorized the company to repurchase up to $750 million of common stock beginning in first quarter of 2021.
Before I move on to our outlook, let me highlight some exciting things that are happening across the company on Slide 15.
On the consumer side, we are focused on national expansion the Citizens Access integrating some of our lending businesses to further develop our national value proposition.
We recently announced the expansion of our national point-of-sale offering for merchants through our Citizens Pay offering and we are continuing to add new merchants to our point-of-sale platform as we expand into new verticals.
We are very excited about an announced expected next week with a major retailer to provide payment options for their customers who wanted transparent and predictable way to finance purchases through a fully digital experience.
In addition, we are making great strides in our digital transformation having launched our new mobile app on Android in the fourth quarter and iOS just this month.
We've seen our Active Mobile Households increased 15% year-over-year and the majority of our deposit transactions, continue to be executed outside of the branch.
In commercial, we have built out a robust corporate finance advisory model and we continue to rank near the top of our peers in customer satisfaction as we help our customers navigate this challenging environment.
And now for some high level commentary on the outlook for 2021 on Slide 16.
We expect NII will be down slightly given NIM expected to be down in the high single digits compared to 2020, which should be largely offset by loan growth.
Loans should be up mid to high single-digits on a spot basis with acceleration in the back half of the year with average loans, up approximately 2%.
Overall, interest earning assets should be up about 1.5% to 2%.
This assumes elevated cash levels come down gradually over the course of 2021.
Fee income is expected to be down high single-digits off the record 2020 level reflecting lower mortgage banking fees from 2020 record levels.
At the same time, we expect good performance in Capital Markets, Wealth and other categories that were impacted by COVID-19 last year.
Non-interest expense is expected to be up just 1.5% to 2% given benefits from our TOP program, partly offset by higher volume related expenses in mortgage and reinvestment in strategic initiatives.
We expect net charge-offs will be in the range of 50 basis points to 65 basis points of average loans with a meaningful reserve release to provision.
Now let's cover the outlook for the first quarter on Slide 17.
We expect NII to be down slightly due to day count.
Both earning assets and NIM are expected to be broadly stable.
Fee income is expected to be down high single digits reflecting lower mortgage banking fees as margins continue to tighten as far as seasonal impacts.
Non-interest expense is expected to be up 2% to 3%, reflecting seasonality and compensation.
We expect net charge-offs to be in the range of 50 basis points to 60 basis points of average loans.
We also expect another quarter with provisions less than charge-offs, based on expected loan growth levels and macroeconomic trends.
To wrap up, this was a strong quarter for Citizens and a good finish to the year as we continue to navigate successfully through the COVID-19 crisis and demonstrate the resilience of our franchise.
We are well positioned to have another strong year in 2021.
With that, I'll hand it back over to Bruce.
And operator, let's open it up to some Q&A.
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board of directors approves $750 million common stock repurchase program.
qtrly net interest income of $1.1 billion decreased 1%.
qtrly provision for credit losses of $124 million compares with $110 million in fourth quarter 2019.
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In second quarter, Cullen/Frost earned $93.1 million or $1.47 per share compared with earnings of $109.6 million, or $1.72 per share in the same quarter of last year and $47.2 million or $0.75 a share in the first quarter of this year.
Beyond the financials, the second quarter was an extraordinary one for Frost.
To add our response to the COVID-19 pandemic, we've been continuing serving customers with appointments in our bank lobbies, to our motor banks, with our online and mobile banking service, to around the clock telephone customer service and at our network of more than 1200 ATMs. I'll talk in more detail about our Houston expansion and our Paycheck Protection Program loans.
But for now, I'd like to point out that we have been completing our organic growth initiatives and still achieving the same award winning level of customer service process known for, despite having more than two thirds of our employees working remotely.
In fact, during the second quarter, we learned that Frost had achieved its highest ever Net Promoter Score with a jump from 82 to 87.
And that's a score that would be the envy of many well known brands, and it's a testament to our core values and our ability to consistently take care of our customer's needs, especially during trying times.
More recently, we learned a process among the banks, that Greenwich and Associates has identified as standouts in their response to the pandemic based on customer surveys.
In fact, Frost was one of only two banks to be named a standout in both the small business banking and middle market banking categories.
I mentioned the Paycheck Protection Program.
As of June 30, when PPP loan applications were initially scheduled to end, we had helped nearly 18,300 of our customers get PPP loans, totaling more than 3.2 billion.
In the state of Texas, Frost was number three in PPP lending with 5% of the loans in San Antonio, Fort Worth and Corpus Christi, Frost was number one in terms of PPP loans approved and in San Antonio we had more PPP loans in Bank of America, Chase and Wells Fargo, combined.
We did well helping businesses of all sizes, but I'm particularly pleased that more than three quarters of our PPP loans were for $150,000 or less, and close to 90% were for 350,000 or less.
PPP applications have been extended into August and we're still taking anywhere from a few to 50 applications per day.
Through July, we've taken an additional 500 applications for over $22 million or an average size of about $45,000.
Meanwhile, we're setting up processes to help borrowers get their loans forgiven.
And the efforts of Frost bankers have helped save hundreds of thousands of jobs.
Those results are more reflective of our culture and our philosophy than even the numbers we're reporting today for the second quarter.
Average deposits in the second quarter were $31.3 billion, up by more than 20% from the $26 billion in the second quarter of last year, and the highest quarterly average deposits in our history.
We're grateful for the confidence our customers has placed in us during these times.
Average loans in the second quarter were $17.5 billion, up by more than 20% from the $14.4 billion in the second quarter of last year.
That includes our strong showing in PPP loans, but our loan total would have been up approximately 5% even without PPP.
In the second quarter our return on average assets was 0.99%, compared to 1.4% in the second quarter of last year.
Our credit loss expense was $32 million in the second quarter, compared to $175.2 million in this first quarter of 2020 and $6.4 million in the second quarter of 2019.
That first quarter provision was significantly influenced by our energy portfolio stress scenario of oil at $9 per barrel for the remainder of 2020.
Oil prices have since stabilized at levels well above that assumption, and the energy borrowing base redeterminations are 95% complete.
Net charge-offs for the second quarter were $41 million, compared to $38.6 million in the first quarter and $7.8 million in the second quarter of last year.
Annualized net charge-offs for the second quarter were 0.94% of average loans.
Second quarter charge-offs were related to energy borrowers that have been discussed for several quarters.
Non-performing assets were $85.2 million at the end of the second quarter compared to $67.5 at the end of the first quarter, and $76.4 at the end of the second quarter last year.
At the current level, non-performing assets represent only 22 basis points of assets which is well within our tolerance level and our level lower than our average non-performing assets over the past nine quarters.
Overall delinquencies for accruing loans at the end of the second quarter were $91 million, or 51 basis points of period end loans.
Those numbers remain within our standards and comparable to what we've experienced in the last -- past several years.
The payment deferrals, we have extended to customers due to the pandemic related slowdown have had some impact on delinquencies.
To the end of the second quarter, we granted 90 day deferrals, totaling $2.2 billion.
Of loans whose deferral period has now ended, which is about $1.1 billion, only $72 million worth have requested a second deferral.
Total problem loans, which we define as risk grade 10 and higher were $674 million at the end of the second quarter, compared to $582 million at the end of the first quarter, which happened to be a multi year low.
A subset of total problem loans, those loans graded 11 and worse, which is synonymous with the regulatory definition of classified totaled $355 million or only 12% of Tier 1 capital.
Energy related problem loans were $176.8 million at the end of the second quarter, compared to $141.7 million for the previous quarter, and $93.6 million in the first quarter of last year.
To put that into perspective, the year in 2016 total problem energy loans totaled nearly $600 million.
Energy loans in general represented 9.6% of our non-PPP portfolio at the end of the second quarter, if you include PPP loans, energy loans were 7.9%.
As a reminder, the peak was 16% back in 2015, and we continued to diversify our loan portfolio and to moderate our company's exposure to the energy segment.
As expected, and as we discussed in the first quarter call, the pandemics economic impacts on our portfolio have been negative, but manageable.
During our last conference call, we discussed portfolio segments that have had increased impact from economic dislocations brought on by the pandemic.
Besides energy, we've narrowed these down to restaurants, hotels, aviation, entertainment and sports, and retail.
The total of these portfolio segments, excluding PPP loans, represented almost $1.6 billion at the end of the second quarter.
Like the energy portfolio, we continually review these specific segments, and we have frequent conversations with those borrowers to assess how they're handling current issues.
Combined with our risk assessments, these conversations influence our loan loss reserve to these segments, which is 2.52% at the end of the second quarter.
Overall, our focus for commercial loans continues to be on consistent balanced growth, including both core loan component, which we define is lending relationships under $10 million in size, as well as larger relationships, while maintaining our quality standards.
We're hearing from customers in all segments that economic impact of the pandemic, as well as the uncertainty ahead and those factors have had an impact on our results.
New relationships are up by about 28%, compared with this time last year, largely because of our strong efforts in helping small businesses get PPP loans.
When we ask these businesses why they came to Frost, 340 of them told us that PPP was a key factor.
The dollar amount of new loan commitments booked through June dropped by about 3%, compared to the prior year.
Regarding new loan commitments booked, the balance between these relationships went from 57% larger and 43% core at the end of the first quarter to 53% larger and 47% core so far in 2020.
And that's about where it was this time last year.
The market remains competitive.
For instance, the percentage of deals lost to structure increased from 61% this time last year to 75% this year.
Our weighted current active loan pipeline in the second quarter was up 24%, compared with the end of the first quarter.
The first quarter numbers were low and reflected the uncertainty about the pandemic's effect.
On the consumer side, we continue to see solid growth in deposits and loans, despite the impact from the pandemic, and the reduction in customer visits to our financial centers.
Overall, net new consumer customer growth rate for the second quarter was 2.2%, compared to the second quarter of 2019.
Same-store sales, however, is measured by account openings were down by 30% through the end of the second quarter, as lobbies were opened only for -- by appointment only and through driving [Indecipherable].
In the second quarter 59% of our account openings came from our online channel, which includes our Frost Bank mobile app.
Online account openings in total were 72% higher, compared to the second quarter of 2019.
The consumer loan portfolio was $1.8 billion at the end of the second quarter, and it increased by 4.3%, compared to last year.
Overall, Frost Bankers' have risen to the unique challenges presented by the pandemic and its results in shutdowns with a mix of keeping our standards and sticking to our strategies, along with a truly remarkable amount of flexibility and adaptability.
Our Houston expansion continues on pace, with four new financial centers opened in the second quarter and two more opened already in the third quarter for a total of 17 of the 25 planned new financial centers.
Those new financial centers include our location in the Third Ward, where customer response has been enthusiastic.
Even though our lobbies are open for appointment only.
Our employees manage those new financial center openings, while most of them are working remotely due to the pandemic, and also while non-stop -- working non-stop to help our business customers stay with PPP loans.
And that commitment and dedication is what Frost workforce philosophy and culture is all about.
As I mentioned earlier, we've gained a lot of new business relationships through our PPP efforts.
And customers that are new to us are learning what a longtime customer has always done, that Frost is a source of strength for customers and our communities and also a source and force for good in people's everyday lives.
I've told our team that their efforts are historic and heroic, and I'm extraordinarily proud of our company and we've been able to help so many small businesses get through these extraordinary times.
It's clear that many pandemic challenges remain, particularly here in Texas, we're seeing the spirit and dedication of Frost employees, who live our philosophy and culture every day, gives me optimism that we will help our customers find a way through this situation and come out stronger.
I want to start out by giving some additional financial information on our PPP loan portfolio.
As Phil mentioned, we generated over $3.2 billion in PPP loans during the quarter.
Our average fee on that portfolio was about 3.2% and translates into about $104 million.
Our direct origination costs associated with these loans totaled about $7.4 million, resulting in net deferred fees of about $97 million, about 20% of the net fees were accreted into interest income during the second quarter.
Looking at our net interest margin, our net interest margin percentage for the second quarter was 3.13%, down 43 basis points from the 3.56% reported last quarter, excluding the impact of our PPP loans, the net interest margin would have been 3.05%.
The 43 basis point decrease in our reported net interest margin percentage, primarily resulted from lower yields on loans and balances at the Fed, as well as an increase in the proportion of balances at the Fed, as a percentage of earning assets, partially offset by lower funding cost.
The taxable equivalent loan yield for the second quarter was 3.95%, down 70 basis points from the previous quarter, impacted by the lower rate environment with the March Fed rate cuts and decreases in LIBOR during the quarter.
The yield on PPP loan portfolio during the quarter was 4.13% and had favorable 3 basis point impact on the overall loan yields for the quarter.
Looking at our investment portfolio, the total investment portfolio averaged $12.5 billion during the second quarter, down about $463 million from the first quarter average of $13 billion.
The taxable equivalent yield on the investment portfolio was 3.53% in the second quarter, up 7 basis points from the first quarter.
Our municipal portfolio averaged about $8.5 billion during the second quarter, flat with the first quarter with the taxable equivalent yield also flat with the first quarter at 4.07%.
At the end of the second quarter over 70% of the municipal portfolio was pre-refunded or PSF insured.
The duration of the investment portfolio at the end of the second quarter was 4.4 years, compared to 4.6 years last quarter.
Looking at our funding sources, the cost of total deposits for the second quarter was 8 basis points, down 16 basis points from the first quarter.
The cost of combined Fed funds purchased and repurchase agreements, which consists primarily customer repos decreased 80 basis points to 0.15% for the second quarter from 0.95% in the previous quarter.
Those balances averaged about $1.3 billion during the second quarter, up about $36 million from the previous quarter.
Looking to non-interest expense, total non-interest expense for the second quarter decreased approximately $3.5 million, or 1.7%, compared to the second quarter last year.
The expense decrease was impacted by the $7.4 million in PPP loan origination costs that were deferred and netted against the PPP processing fee, which were amortized into interest income as a yield adjustment over the life of those PPP loans.
Excluding the favorable impact of deferring those origination fees related to PPP loans, total non-interest expenses would have been up $3.8 million, or 1.9%, compared to the second quarter last year.
In addition to the reduced expense run rate during the second quarter, due to the pandemic effect on the business environment, we continue to focus on managing our discretionary spending and looking for ways to operate more efficiently.
As we look out for the full-year, adding back to $7.4 million in deferred expenses related to the PPP loans I mentioned previously, we currently expect annual expense growth of something around 6%, which is down 2.5 percentage points from the 8.5% growth guidance we gave last quarter.
Regarding income tax expense, we did recognize a $2.6 million one-time discrete tax benefits during the quarter related to an asset contribution to a charitable trust during the second quarter.
Excluding the impact of that item, our effective tax rate on a year-to-date earnings would have been about 3.1%.
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compname posts q2 earnings per share $1.47.
q2 earnings per share $1.47.
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In the second quarter, Cullen/Frost earned $116.4 million or $1.80 a share compared with earnings of $93.1 million or $1.47 a share reported in the same quarter last year and compared with $113.9 million or $1.77 a share in the first quarter.
In the current environment, our company is in a strong position to benefit from the rebound in economic activity, and we will continue our organic growth strategy while taking steps to enhance Frost's experience for our customers and our employees.
As expected, economic conditions have continued to weigh on conventional loan demand.
Overall, average loans in the second quarter were $17.2 billion, a decrease of 1.7% compared to $17.5 billion in the second quarter of last year.
Excluding PPP loans, second quarter average loans of $14.6 billion represented a decline of 3% compared to second quarter of 2020.
However, we're seeing evidence of loan growth beginning to materialize as non-PPP loans trended up in the month of June, and that upward trend has continued into July.
Average deposits in the second quarter were $38.3 billion, an increase of more than 22% compared with $31.3 billion in the second quarter of last year.
Our return on average assets and average common equity in the second quarter were 1.02% and 11.18%, respectively.
We did not report a credit loss expense for the second quarter.
Our asset quality outlook is stable.
And in general, problem assets are declining in number.
New problems have dropped significantly and are at pre-pandemic levels.
Net charge-offs for the second quarter totaled $11.6 million compared with $1.9 million in the first quarter.
Annualized net charge-offs for the second quarter were four basis points of average loans.
Nonaccrual loans were $57.3 million at the end of the second quarter, a slight increase from $51 million at the end of the first quarter and primarily represented the addition of three smaller energy loans, which had previously been identified as problems.
A year ago, nonaccrual loans stood at $79.5 million.
Overall delinquencies for accruing loans at the end of the second quarter were $97.3 million or 59 basis points of period-end loans and were at manageable pre-pandemic levels.
We've discussed in the past $2.2 billion in 90-day deferrals granted to borrowers earlier in the pandemic.
As of the end of the second quarter, there were no active deferrals.
Total problem loans, which we define as risk grade 10 and higher were $666 million at the end of the second quarter compared with $774 million at the end of the first quarter.
I'll point out that energy loans declined as a percentage of our portfolio, falling to 6.98% of our non-PPP portfolio at the end of the second quarter as we continue to make progress toward a mid-single-digit concentration level of this portfolio over time.
Our teams continue to analyze the non energy portfolio segments that we considered most at risk from pandemic impacts.
As of the second quarter, those segments are restaurants, hotels and entertainment and sports.
Those of these portfolio segments, the total, excluding PPP loans, represented $675.1 billion at the end of the second quarter, and our loan loss reserve for these segments was 8.6%.
The credit quality of these individual credits in these segments is currently mostly stable or better compared to the end of the first quarter.
We also continue to add to our customer base.
Through the midpoint of this year, we added 7% more new commercial relationships than we did in 2020, which included the outsized second quarter of 2020 when PPP activity was so strong.
Looking at recent trends, our new commercial relationships were 511 in the fourth quarter of 2020, 554 in the first quarter of this year and 643 in our most recent quarter.
So we're seeing good momentum in this area.
We're also seeing good momentum in the insurance business, particularly in the benefits and property and casualty segment.
Were up about 6% in both of those in terms of new customers.
And also, as many others, we're seeing good growth in wealth management from assets under management with these good markets, but have also seen an increase of around 3% in new customers.
In the time since we began our PPP efforts, just under 1,000 new commercial relationships identified our assistance in the PPP process as a significant reason for moving to Frost.
New loan commitments booked during the second quarter, excluding PPP loans, were up by 9% compared to the second quarter last year and up by 45% on a linked quarter basis.
Our current weighted pipeline is 12% higher than one year ago, 17% higher than last quarter and 38% higher than the same time in 2019.
The increases are mostly due to C&I.
Our current weighted pipeline is as high as it's ever been, so we hope this points for a good third quarter for booking new loans.
At the same time, it has to be said that competition is intense.
In total, the percentage of deals lost to structure of 56% was down from the 75% we saw this time last year, but that's really more a factor of the increase in price competition rather than more market discipline around structure.
We were extremely proud to have completed our 25 branch Houston expansion initiative in the second quarter, and we continue to be very pleased with the results.
It represents a tremendous achievement for our outstanding staff.
Let me update you where we stand through the second quarter, and it excludes PPP loans.
Our numbers of new households were 141% of target and represents almost 11,000 new individuals and businesses.
Our loan volumes were 215% of target and represented $300 million -- $310 million in outstandings and about 80% represented commercial credits with about 20% consumer.
Regarding deposits, at $433 million, they represent 116% of target, and they represent about 2/3 commercial and 1/3 consumer.
Once again, I hope that we've shown that the character of the business we're generating through the expansion is very consistent with the overall company.
And its profitability is weighted toward small and midsized businesses and complemented by consumer as well as other lines of business including wealth management and insurance.
Consumer banking also continues to see outstanding growth.
In just the first six months of this year, we've already surpassed our all-time annual growth for new customer relationships.
This represents about 13,500 net new checking customers.
Our previous high was 12,700 for full year 2019 and it's all organic growth.
We worked hard to lower barriers to entry for potential customers with improved product offerings and our geographic expansion.
Houston accounts for about 1/3 of this relationship growth.
Their annual growth rate for consumer customers is up over 13%.
That compares to 4% in 2018 before we started the expansion.
We were excited to announce this month that we launched a new feature called Early Pay Day, which gives customers access to direct deposits up to two days before the money arrives in their account.
And we put this in place in time for customers to see the effect from the IRS Child Tax Credit payments, and we've already heard great comments from customers who've used Early Payday to pay bills.
This makes a difference in the lives of people who live paycheck to paycheck, and that was on top of our $100 overdraft grace feature that we rolled out in April.
Also, earlier this month, we reached an ATM branding partnership with Cardtronics that will result in us having more than 1,725 ATMs in our network across Texas.
That is, by far, the largest ATM network in the state.
But just as important, it gives us the largest ATM network in the Dallas-Fort Worth region as we began our expansion in Dallas early next year.
I mentioned PPP earlier and how our efforts helped thousands of small businesses, and we closed out the second round of PPP with more than 13,000 loans for $1.4 billion.
And combined with the first round, that gives us a PPP program total of more than 32,000 loans and $4.7 billion in deposits -- $4.7 billion in outstandings.
The historic effort that Frost Bankers put into helping borrowers get PPP loans has now shifted to the forgiveness process.
Because borrowers for the first round are approaching payment dates, if they don't apply for forgiveness, we've increased our communication to them and worked on ways to make the forgiveness application process simpler.
We've already submitted 21,000 forgiveness applications and received approval on nearly 19,100 of them for $3 billion.
That's close to the entire first round total.
We continue to be optimistic about the economy and what lies ahead.
Looking first at our net interest margin.
Our net interest margin percentage for the second quarter was 2.65%, down seven basis points from the 2.72% reported last quarter.
The decrease was impacted by a higher proportion of earning assets being invested in lower-yielding balances at the Fed in the second quarter as compared to the first quarter, partially offset by the positive impact of the PPP loan portfolio.
Interest-bearing deposits at the Fed averaged $13.3 billion or 31% of our earning assets in the second quarter, up from $9.9 billion or 25% of earning assets in the prior quarter.
Excluding the impact of PPP loans, our net interest margin percentage would have been 2.37% in the second quarter, down from an adjusted 2.59% for the first quarter with all of the decrease resulting from the higher level of balances at the Fed in the second quarter.
The taxable equivalent loan yield for the second quarter was 4.28%, up 41 basis points from the previous quarter and was impacted by an acceleration of PPP forgiveness during the quarter which accelerated the recognition of the associated deferred fees.
Excluding the impact of PPP loans, the taxable equivalent loan yield would have been 3.80%, up three basis points from the prior quarter.
To add some additional color on our PPP loans, forgiveness payments received accelerated during the quarter, totaling $1.3 billion compared to the $580 million received in the prior quarter.
As a result of the accelerated forgiveness, interest income, including fees on PPP loans totaled about $45 million in the second quarter, up significantly from the approximately $30 million recorded in the first quarter.
Given our current projections on the speed of forgiveness of the remainder of our PPP loans, we currently expect that the interest income on PPP loans recognized in the third quarter would be less than 1/2 of the $45 million recorded in the second quarter.
Total forgiveness payments through the second quarter were approximately $2.7 billion.
And total PPP loans at the end of June were $1.9 billion, down from the $3.1 billion at the end of March.
At the end of the second quarter, we had approximately $38 million in net deferred fees remaining to be recognized, and we currently expect a little over 70% of that to be recognized this year.
Looking at our investment portfolio.
The total investment portfolio averaged $12.3 billion during the second quarter, up about $46 million from the first quarter.
The taxable equivalent yield on the investment portfolio was 3.36% in the second quarter, down five basis points from the first quarter.
The yield on the taxable portfolio, which averaged $4.2 billion was 2.01%, down five basis points from the first quarter as a result of higher premium amortization associated with our agency MBS securities, given faster prepayments.
Our municipal portfolio averaged about $8.1 billion during the second quarter, down $104 million from the first quarter, with a taxable equivalent yield of 4.09%, flat with the prior quarter.
At the end of the second quarter, 78% of the municipal portfolio was pre-refunded or PSF-insured.
The duration of the investment portfolio at the end of the second quarter was 4.4 years, in line with the first quarter.
Investment purchases during the quarter were approximately $680 million and consisted of about $400 million in municipal securities with a TE yield of about 2.30% and about $190 million in 20-year treasuries with the remainder in MBS securities.
Regarding noninterest expense, looking at the full year 2021, we currently expect an annual expense growth rate of around 3% from our 2020 total reported noninterest expenses.
And regarding income tax expense, the effective tax rate for the quarter was 11.3%, up from the 6.4% reported in the first quarter as a result of higher earnings, but also impacted by lower tax benefits realized from employee stock option activity in the second quarter as compared to the first.
We currently are projecting a full year 2021 effective tax rate in the range of 9% to 9.5%.
Regarding the estimates for full year 2021 earnings.
Given our second quarter results and recognition of lower PPP fee accretion for the remainder of the year, we currently believe the current mean of analyst estimates of $6.33 is reasonable.
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q2 earnings per share $1.80.
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In the third quarter, Cullen/Frost earned $106.3 million or $1.65 per share compared with earnings of $95.1 million or $1.50 per share reported in the same quarter of last year.
And this compared with $116.4 million or $1.80 per share in the second quarter.
We continue to focus on our organic strategy while the economy works to move past supply chain issues and other lingering effects of the pandemic.
Average deposits continued their strong increase in the third quarter and were $39.1 billion, an increase of 19% compared with $32.9 billion in the third quarter of last year.
Overall, average loans in the third quarter were $16.2 billion compared with $18.1 billion in the third quarter of 2020, but this included the impact of PPP loans.
Excluding PPP loans, third quarter average loans of $14.8 billion were essentially flat from a year ago but up an annualized 6% on a linked quarter basis.
And looking forward, we're very encouraged about the outlook for loan growth.
New loan commitments booked through the third quarter excluding PPP loans were up by 11% compared to the first nine months of last year.
For the quarter, new loan commitments were up by 6% on a linked quarter basis.
We were especially pleased that the linked quarter increase was due primarily to C&I commitments, which were up 30%.
Our current weighted pipeline is 41% higher than one year ago and 22% higher than last quarter.
The increases are in both C&I, up 22%; and CRE, up 28%.
The market continues to be very competitive.
In the third quarter, 69% of the deals we lost were due to structure compared to 50% in the quarter before.
We also continue to add to our commercial customer base, and we recorded 619 new commercial relationships during the quarter.
And while this was down from the same quarter a year ago when we were experiencing incredible PPP success, it is 2/3 higher than the quarter immediately before the PPP program.
As with the second quarter, we did not report a credit loss expense in the third quarter.
Our asset quality outlook is stable and in general, problem assets are declining in number.
New problems have dropped to pre-pandemic levels.
Net charge-offs for the third quarter totaled $2.1 million compared with $1.6 million in the second quarter.
Annualized net charge-offs for the third quarter were five basis points of average loans.
Nonaccrual loans were $57.1 million at the end of the third quarter, a slight decrease from the $57.3 million at the end of the second quarter.
Overall, delinquencies for accruing loans at the end of the third quarter were $95.3 million or 60 basis points of period-end loans, and these are manageable pre-pandemic levels.
What started out as $2.2 billion in 90-day deferrals granted to borrowers early in the pandemic were completely gone as of the end of the third quarter.
Total problem loans, which we define as risk grade 10 and higher, were down slightly to $635 million at the end of the third quarter compared with $666 million at the end of the second quarter.
In the third quarter, we continued making progress toward our goal of mid-single-digit concentration level in the energy portfolio over time, with energy loans falling to 6.5% of our non-PPP portfolio at the end of the quarter.
Our teams continue to analyze the nonenergy portfolio segments that we considered the most at risk from pandemic impacts.
As of the third quarter, those segments are represented by restaurants, hotels and entertainment and sports.
The total of these portfolio segments excluding PPP loans represented $695 million at the end of the third quarter, and our loan loss reserve for these segments was 8.8%.
The credit quality of individual credits in these segments is currently most stable -- mostly stable or better compared to the end of the second quarter.
We reported in the second quarter that we had completed our 25-branch Houston expansion initiative, and we're very pleased with the results.
We've identified eight more locations to open in the coming months, and that process is underway.
Let me update you where we stand through the third quarter with the Houston expansion excluding PPP loans.
Our numbers of new households were 134% of target and represented more than 12,200 new individuals and businesses.
Our loan volumes were 177% of target and represented $371.4 million in outstandings, and about 80% of this represents commercial credits with about 20% consumer.
Deposits surpassed $0.5 billion and were 111% of target.
Commercial deposits accounted for 2/3 of the total.
In the meantime, we're also preparing for our upcoming 28-branch expansion project in the Dallas region, which will kick off with the first new financial center opening early next year and continuing into 2024.
The Dallas expansion will follow our Houston model, and we will employ the lessons learned during our team's successful rollout.
I'll continue to emphasize that the business we are generating through our expansion strategy is consistent with the overall company.
Its profitability is weighted toward small and midsized businesses, but it also has complemented wealth management, insurance, and of course, consumer banking, which continues to see tremendous growth.
For example, through the first six months of this year, we had already surpassed consumer banking's all time annual growth for new customer relationships, which was 12,700 in 2019.
At the end of the third quarter this year, this had risen to 19,974 net new checking customers.
That's already more than 150% of our previous annual record.
We've worked hard to lower barriers to entry for potential customers with improved product offerings and physical distribution.
For example, besides overdraft grace which we introduced in April and Early Pay Day which we announced in July, we also recently established an ATM branding partnership with Cardtronics that resulting -- resulted in us having by far the largest ATM network in the state.
In addition, after over two years of study, we've begun the process of putting in place the infrastructure to add residential mortgages to our suite of consumer real estate products in late 2022.
HELOC, home improvement and purchase money second loans, which has steadily grown to in excess of $1.3 billion.
Utilizing best-in-class technology will allow us to provide Frost level of world-class customer service as we build this portfolio over time in response to customer demand.
Finally, I want to commend our team working on PPP loans.
Nearly 90% of the 32,500 loans or $4.7 billion have already been helped with the loan forgiveness process.
That includes upwards of 97% of the first-round loans from 2020.
Our team continues to put in outstanding work to execute our strategies, whether it's PPP, our expansion projects, or the enhancements we've made to our customer experience.
I believe we've got the best team in the financial services industry.
They are why I continue to be optimistic about our company and our prospects for success.
Looking first at our net interest margin.
Our net interest margin percentage for the third quarter was 2.47%, down 18 basis points from 2.65% reported last quarter.
The decrease was primarily the result of a higher proportion of earning assets being invested in lower-yielding balances at the Fed in the third quarter as compared to the second quarter, and to a lesser extent, the impact of a lower PPP loan volumes and their related yields compared to the prior quarter.
Interest-bearing deposits at the Fed averaged $15.3 billion or about 35% of our average earning assets in the third quarter, up from $13.3 billion or 31% of average earning assets in the prior quarter.
Excluding the impact of PPP loans, our net interest margin percentage would have been 2.27% in the third quarter, down from an adjusted 2.37% for the second quarter, with all of the decrease resulting from the higher level of balances at the Fed in the third quarter.
The taxable equivalent loan yield for the third quarter was 4.16%, down 12 basis points from the previous quarter.
Excluding the impact of PPP loans, the taxable equivalent loan yield would have been 3.74%, down six basis points from the prior quarter.
To add some additional color on our PPP loans, total PPP loans at the end of September were $828 million, down from $1.9 billion at the end of June.
Forgiveness payments received during the third quarter were higher than we had projected, resulting in an acceleration in the recognition of the net deferred fees during the quarter.
At the end of the third quarter, we had only about $11.5 million in net deferred fees remaining to be recognized, and we currently expect about 75% of that to be recognized in the fourth quarter.
Looking at our investment portfolio.
The total investment portfolio averaged $12.5 billion during the third quarter, up about $209 million from the second quarter.
The taxable equivalent yield on the investment portfolio was 3.35% in the third quarter, down one basis point from the second quarter.
The yield on the taxable portfolio which averaged $4.1 billion was 2.03%, up two basis points from the second quarter.
Our municipal portfolio averaged about $8.4 billion during the third quarter, up $230 million from the second quarter, with a taxable equivalent yield of 4.04%, down five basis points from the prior quarter.
At the end of the third quarter, 78% of the municipal portfolio was pre-refunded or PSF-insured.
The duration of the investment portfolio at the end of the third quarter was 4.5 years, up slightly from 4.4 years in the second quarter.
We made investment purchases toward the end of September of approximately $1.5 billion, consisting of about $900 million in MBS agency securities with a yield of about 2%, about $500 million in treasuries yielding 1.07% with the remainder in municipal securities.
Regarding noninterest expense, looking at the full year 2021, we currently expect an annual expense growth rate of around 3% over our 2020 total reported noninterest expenses, which is consistent with our previous guidance.
Regarding the estimates for full year 2021 earnings, given our third quarter results and the recognition of lower PPP fee accretion for the fourth quarter, we currently believe that the current mean of analyst estimates of $6.48 is reasonable.
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q3 earnings per share $1.65.
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In the fourth quarter, Cullen/Frost earned $101.7 million or $1.60 per share, compared with earnings of $117.2 million and $1.82 a share reported in the same quarter a year ago.
For the full year, Cullen/Frost earned $435.5 million or $6.84 a share compared with earnings of $446.9 million or $6.90 a share reported in 2018.
The lower interest rate environment impacted our results, as you would expect.
However, our team continues to execute our strategy of pursuing consistent above-average organic growth across our enterprise and we are investing for the long term, while maintaining our quality standards.
Our return on average assets was 1.21% in the fourth quarter compared to 1.48% in the fourth quarter of last year.
Average deposits in the fourth quarter of $27.2 billion were up 2.6% compared to the fourth quarter of last year, while average loans were up 5.4%.
Our provision for loan losses was $8.4 million in the fourth quarter compared to $8 million in the third quarter of this year and $3.8 million in the fourth quarter of 2018.
Net charge-offs for the fourth quarter were $12.7 million compared with $6.4 million in the third quarter and $9.2 million in the fourth quarter of last year.
Fourth quarter annualized net charge-offs were 34 basis points of average loans.
Non-performing assets were $109.5 million at the end of the fourth quarter compared with $105 million in the third quarter and $74.9 million in the fourth quarter of last year.
Overall delinquencies for accruing loan at the end of the fourth quarter were $58.2 million and that was 39 basis points of period end loans.
And those numbers remain well within our standards and comparable to what we've experienced in the past several years.
And overall, our credit quality remains good.
Total problem loans, which we define as risk grade 10 and higher were $511 million at the end of the fourth quarter compared to $487 million in the third quarter of this year and $477 million in the fourth quarter of last year.
The increase in the fourth quarter related primarily to the energy portfolio.
Energy related problem loans were $132.4 million at the end of the fourth quarter compared to $87.2 million for the third quarter and $115.4 million in the fourth quarter of last year.
The energy-related problem loan total is mostly attributable to three borrowers with whom we've been working for several quarters.
Energy loans in general represented 11.2% of our portfolio at the end of the fourth quarter, up from the previous quarter but well below our peak of more than 16% in 2015.
Our focus for commercial loans continues to be on consistent, balanced growth, including both the core component, which we define as lending relationships under $10 million in size as well as larger relationships, while maintaining our quality standards.
The balance between these relationships went from 52% larger and 48% core at the end of 2018 to 57% larger and 43% core at the end of 2019.
The movement toward larger loans in 2019 was mostly due to activity in the fourth quarter, where some quality new energy relationships were added after exiting a number of credits during the year.
New relationships increased 4% versus the fourth quarter of a year ago.
The dollar amount of new loan commitments booked during the fourth quarter was up sharply, increasing 75% from a year ago and 44% from the prior quarter.
Even excluding the strong energy growth we saw in the fourth quarter, new loan commitments grew 42% versus a year ago and 20% from the prior quarter and represented good increases in both C&I and CRE.
That said, quality deals are hard to come by.
In 2019, we booked just 3% more loan commitments compared to 2018 despite looking at 16% more deals.
In CRE, we saw our percentage of deals lost to structure increase from 63% in 2018 to 69% in 2019.
Our weighted current active loan pipeline in the fourth quarter was up by about 9% overall compared to the prior quarter and was driven by a 20% growth in C&I opportunities.
Of the 10 new financial centers that we've opened so far in the Houston region, four were opened in the fourth quarter.
We expect to open one more Houston area financial center in the current quarter on our way to a total of 25 new financial centers and we've already hired more than 150 of the approximately 200 employees we expect to staff this expansion.
Those new financial center openings benefit both commercial and consumer banking.
Let's look at our consumer business.
We added almost 13,000 net new customers -- consumer customers in 2019, an increase of 48% from a year ago.
That represented a 3.8% increase in the total number of consumer customers, all of it representing organic growth.
In the fourth quarter 32% of our account openings came from our online channel which includes our Frost Bank mobile app.
This channel continues to grow rapidly.
In fact, online account openings were 30% higher compared to the fourth quarter of 2018.
The consumer loan portfolio averaged $1.7 billion in the fourth quarter, increasing by 1.2% compared to the fourth quarter last year.
Frost Bankers have done a great job expanding our presence in growing markets.
Our overall strategy of sustainable organic growth is serving us well.
The interest rate environment continues to present challenges to our industry, but we remain focused on the fundamentals and growing our lines of business in line with our quality standards.
2019 had its share of challenges but also had its share of achievements.
Besides adding the new financial centers in Houston that I mentioned, we also expanded into a completely new market where we opened our first financial center in Victoria, Texas and we completed our corporate headquarters move to the new Frost Tower in downtown San Antonio and the culmination of a process that began six years ago.
Our commitment to customer service was confirmed when Frost received the highest ranking in customer satisfaction in Texas in J.D. Power's U.S. Retail Banking Satisfaction Study for the 10th consecutive year and received more Greenwich Excellence and Best Brand awards for small business and middle market banking than any bank in the nation for the third consecutive year.
That's a tribute to the dedication of everyone at Frost who works hard every day to take care of our customers and implement our strategies and that dedication is what sets Frost apart from other financial service companies.
I'll make a few comments about the Texas economy before providing some additional information about our financial performance for the quarter and I'll close with our guidance for full year 2020.
All of the Texas macroeconomic numbers I'll mention here are sourced from the Dallas office of the Federal Reserve.
Texas job growth was a very strong 4% in November and the Dallas Fed now estimates 1.9% Texas job growth for full year 2019.
December statewide unemployment of 3.5% uptick slightly from the historically low 3.4% level seen in each of the six months through November.
In terms of employment growth by industry, as of November, construction had the strongest employment growth in Texas with 11.5% growth for the month and growth of 5% for the year-to-date period through November.
Financial activities was the industry with the second fastest job growth at 3.5% year-to-date through November.
Energy was the only sector that showed meaningfully negative Texas job growth, down 2.7% year-to-date through November.
According to the Dallas Fed surveys, activity in the Texas services sector accelerated again in the fourth quarter and revenue growth in this sector has remained in positive territory every month since December of 2009.
Looking at individual markets, Houston economic growth remains above the historical average and the Dallas Fed stated that as of November data suggests continued moderate growth ahead.
Job growth in the Houston region accelerated to a 2.8% rate in the three months through November, compared to a more modest 1.6% rate for the full year through November professional and business services and education and health services led Houston job growth over the three months through November growing at 8.2% and 7.7% respectively over the same period a year earlier.
Regarding the DFW Metroplex the Dallas Business Cycle Index maintained by the Dallas Fed expanded at a 5% annual rate in the fourth quarter compared to 4.8% in the third quarter, while the Fort Worth Business Cycle Index expanded at a consistent 4.1% rate in the second half of the year.
For the DFW Metroplex, November job growth remains strong at a 4.8% annualized rate, and area unemployment remained near multi-year lows at 3.2% in Dallas and 3.3% in Fort Worth.
The Austin economy has also remained healthy in November and the Dallas Fed's Austin Business Cycle Index has now been in expansion territory for more than 10 years with index growth remaining at or above the region's historical 6% average for the past nine years.
In the three months ending in November, Austin area job growth moderated to 2.4%.
Austin's unemployment rate remained at 2.7% in November for the fourth consecutive month.
The San Antonio region posted strong economic growth in November with the Dallas Fed San Antonio Business Cycle Index, continuing to grow above its long-term average.
The San Antonio Business Cycle Index grew at a 5.5% rate in November and San Antonio job growth was 4.7% for the three months through November with area unemployment remaining at 3.1%.
Permian Basin payrolls remained flat through November and the unemployment rate has ticked up in recent months.
While the rig count has generally declined in recent months, oil production has continued to increase.
Permian region job declines in the mining, manufacturing and government sectors were offset by job growth in the leisure and hospitality, professional and business services, information and trade, transportation and utility sectors for the year-to-date period through November, resulting in overall flat performance for jobs in the region.
Despite the lack of job growth in the Permian region, November unemployment remained low at 2.4% for the second consecutive month.
Our net interest margin percentage for the fourth quarter was 3.62%, down 14 basis points from the 3.76% reported last quarter.
The decrease primarily resulted from lower yields on loans and balances at the Fed as well as an increase in the proportion of balances at the Fed as a percentage of earning assets, partially offset by lower funding costs.
The taxable equivalent loan yield for the fourth quarter was 4.88%, down 28 basis points from the third quarter, impacted by the lower rate environment with September and October Fed rate cuts.
The total investment portfolio averaged $13.6 billion during the fourth quarter, up about $197 million from the third quarter average of $13.4 billion.
The taxable equivalent yield on the investment portfolio was 3.37% in the fourth quarter, down 6 basis points from the third quarter.
Our municipal portfolio averaged about $8.4 billion during the fourth quarter, up about $193 million from the third quarter.
The municipal portfolio had a taxable equivalent yield for the fourth quarter of 4.8%, flat with the previous quarter.
At the end of the fourth quarter, about two-thirds of the municipal portfolio was PSF insured.
During the fourth quarter, approximately $1.4 billion of our treasury securities that were yielding about 1.51% matured.
As insurance against the potential backdrop of flat to down rates for an extended period of time, we made the decision to add duration to our investment portfolio.
During the fourth quarter, we purchased about $1.5 billion in securities to replace the treasuries that matured.
During the quarter, we purchased $500 million in 30 year treasuries yielding about 2.27%, approximately $700 million in agency mortgage-backed securities yielding about 2.37% and about $300 million in municipal securities with a TE yield of 3.3%.
As a result of the maturities and purchases I just mentioned, the duration of the investment portfolio at the end of the quarter was 5.4 years compared to 4.3 years last quarter.
Looking at our funding sources, the cost of total deposits for the fourth quarter was 29 basis points, down 10 basis points from the third quarter.
The combined cost of -- the cost of combined Fed funds purchased and repurchase agreements which consists primarily of customer repos decreased 32 basis points to 1.21% for the fourth quarter from 1.53% in the previous quarter.
Those balances averaged about $1.42 billion during the fourth quarter, up about $126 million from the previous quarter.
Moving to non-interest expense; total non-interest expense for the quarter increased approximately $21.1 million or 10.6% compared to the third quarter -- excuse me, the fourth quarter last year.
Excluding the impact of the Houston expansion and the operating costs associated with our headquarters move in downtown San Antonio, non-interest expense growth would have been approximately 6.3%.
So again, regarding the estimates for full year 2020 earnings, we currently believe that the FactSet mean of $6.13 is reasonable.
Our assumptions do not include any rate cuts in 2020.
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compname reports q4 earnings per share $1.60.
q4 earnings per share $1.60.
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I'm Martin Jarosick, Vice President-Investor Relations.
These statements are not guarantees of future performance and involve risks, uncertainties, and assumptions that are difficult to predict.
Therefore, actual outcomes and results may differ materially from what is expressed or implied in any statements.
More detailed information about factors that may affect our performance may be found in our filings with the SEC, which are available on our website.
Now, let me introduce Tony Will, our President and CEO.
Strong nitrogen demand and lower overall production have tightened the global supply demand balance, supporting much higher prices than in recent years.
At the same time, energy spreads between North America and high-cost regions have expanded considerably, increasing margin opportunities for our cost advantaged network.
These factors helped drive an increase in adjusted EBITDA of nearly 25% compared to last year, and we produced our strongest first half financial results in six years.
Additionally, the business continues to generate strong free cash flow, giving us tremendous flexibility as we focus on achieving investment grade metrics and executing our clean energy initiatives.
The first half was not without its challenges, including the natural gas-driven production interruptions we described on the first quarter call.
The first half also saw a continued demonstration of the harm the UAN industry in the United States faces from subsidized and dumped imports from Russia and Trinidad.
Until the last few years, UAN earned a substantial premium to other upgraded nitrogen products due to the higher capital investment required to produce it and the meaningful agronomic and operational benefit it offers to farmers.
As you can see from our recent results, UAN now trades at a significant discount to all upgraded nitrogen products due to unfair trade practices.
We have taken the necessary steps to address this situation by petitioning the Department of Commerce and International Trade Commission to initiate anti-dumping and countervailing duty investigations.
We look forward to the result of the ITC's preliminary vote later this week.
Looking forward, we are very bullish about the next two years.
As Bert will describe in a moment, the need to replenish global coarse grains stocks driving agricultural demand along with the impact of increased economic activity driving industrial demand, should support all-time record global nitrogen demand over the next two years.
Forward energy curves are also very favorable over this timeframe.
We expect these factors to help keep the global nitrogen supply and demand balance much tighter than we've seen in recent years, supporting an extended period of higher nitrogen pricing and higher margins for our cost advantaged network.
Longer term, we believe increased demand for ammonia and its clean energy attributes will become a significant factor in the tighter supply and demand balance, driving further value for our network.
We continue to see broad interest in clean hydrogen and ammonia to help meet the world's clean energy needs.
As we continue to have discussions with market participants, our focus remains on being at the forefront of this significant opportunity, from positioning our network to be the world's leader for blue and green ammonia production to collaborating with other global leaders where our unique capabilities can provide value.
We are pleased with the progress we've made and look forward to additional developments in the coming months.
The global nitrogen supply and demand balance remains far tighter than we have seen in recent years, underpinned by strong agricultural and industrial demand plus higher energy prices in Europe and Asia.
This has created a highly favorable pricing environment that has persisted into the second half of this year.
Based on the agricultural and energy outlook we see today, we believe a positive pricing environment for fertilizer will remain in place at least into 2023.
Strong global nitrogen demand is being led by the world's need to replenish coarse grains stocks.
The global coarse grains stocks-to-use ratio was the lowest since 2012, entering this year's spring planting season, commodity prices have risen significantly in response and farmers are incentivized to maximize yield with fertilizer applications.
Given this, we expect to see sustained demand in the second half led by India and Brazil.
We expect similar strength from North America and Europe leading into the 2022 application season.
We had a positive start to meeting this demand a few weeks ago when we launched our UAN Fill Program.
We have built a solid order book for the third quarter at an all-equivalent price of $285 per ton, though prices remain at a significant discount to urea for the reasons Tony mentioned.
Further out, we expect that high demand for coarse grains, especially from China, will contribute to persistent low global stocks into next year.
As a result, we believe that stocks will still need to be replenished at least into 2023, supporting continued strong nitrogen demand.
Increased economic activity is also driving higher global industrial demand for nitrogen.
In North America, we have seen diesel exhaust fluid sales rise above pre-pandemic levels.
Our first half DEF sales were a Company record and we expect overall demand will continue to grow.
We've also seen higher demand for ammonia and nitric acid from our industrial customers.
Globally, industrial related demand in China and from phosphate producers has also increased.
While we expect demand to remain strong for some time, we believe that global fertilizer inventory in the channel today is low and will need to be rebuilt.
So far in 2021, high energy costs in Europe and Asia have lowered operating rates and reduced supply availability, particularly for ammonia and urea, further supporting global pricing.
As you can see on Slide 9, energy costs in these regions have increased to over $14 per MMBtu and Eastern European producers have become the global marginal producer for the time being.
The higher energy cost has steepened the global nitrogen cost curve substantially, increasing margin opportunities for low-cost producers such as CF.
Forward curve suggests CF will benefit from favorable energy differentials for the foreseeable future.
As a result, we believe we have a tremendous opportunity ahead of us as we leverage our manufacturing, distribution and logistics capabilities to deliver for our customers.
For the first half of 2021, the Company reported net earnings attributable to common stockholders of $397 million or $1.83 per diluted share.
EBITDA was $994 million and adjusted EBITDA was $997 million.
The trailing 12 months net cash provided by operating activities was approximately $1.2 billion and free cash flow was $700 million.
Based on the outlook Tony and Bert have shared, we are well positioned to build on these results and continue to generate significant free cash flow.
First, we raised our estimate for capital expenditures for 2021 from around $450 million to approximately $500 million.
The increase is driven primarily by our decision to pull a significant maintenance event scheduled for next year into this year.
We believe that performing this activity in 2021 is best for the asset and reduces the risk of an unplanned outage during the 2022 spring application season.
Going forward, we expect capital expenditures to return to the range of $450 million per year.
With this additional maintenance project, the high level of previously planned maintenance, and the additional maintenance from severe weather in February, we estimate that gross ammonia production and sales volume will be around 9.5 million tons and 19 million product tons respectively; both at the low end of our forecasts earlier this year.
Looking into 2022, we have a more typical maintenance schedule and we'd expect to return to approximately 10 million tons of ammonia production and sales volume of 19.5 million to 20 million product tons.
Second, we are taking additional steps in line with our focus on achieving investment grade ratings and positioning the Company to execute our clean energy initiatives.
We have announced that we will redeem $250 million of our senior notes due June 2023, which will reduce our gross debt to $3.5 billion.
We expect to lower our gross debt to $3 billion by or before the maturity of the 2023 notes.
We also continue to return cash to our shareholders through quarterly dividend and opportunistic share repurchases at attractive levels.
With that, Tony will provide some closing remarks before we open the call to Q&A.
They successfully managed many challenges in the first six months of the year, setting us up well for the second half.
Most importantly, we did this safely with our recordable incident rate at the end of June at just 0.28 incidents per 200,000 labor hours, significantly better than industry averages.
As we look ahead, we expect strong agricultural and industrial demand to create all-time record global nitrogen demand.
Forward curve show very favorable energy spreads to Europe and Asia over the same timeframe, which should support robust margins and cash generation.
We see good progress on our clean energy initiatives.
Taken together, we are well positioned to create significant shareholder value in the near and longer term.
With that, operator, we will now open the call to questions.
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compname reports first half 2021 net earnings of $397 million, ebitda of $994 million, adjusted ebitda of $997 million.
projects capital expenditures for full year 2021 will be in range of $500 million.
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I'm Martin Jarosick, Vice President, Investor Relations for CF.
These statements are not guarantees of future performance and involve risks, uncertainties and assumptions that are difficult to predict.
Therefore, actual outcomes and results may differ materially from what is expressed or implied in any statement.
More detailed information about factors that may affect our performance may be found in our filings with the SEC, which are available on our website.
Now let me introduce Tony Will, our President and CEO.
Yesterday, we posted our financial results for the first nine months of 2020, in which we generated adjusted EBITDA of just over $1 billion.
We feel good about our position as we near the end of the year.
This is because there can be significant shifts across quarters due to weather or other events.
However, that spikiness tends to smooth out over time so a longer time period provides a better picture of actual performance than focusing on an individual quarter.
As of today, with two months to go and most of the fall ammonia season still ahead of us, we continue to expect that our full year 2020 results will end up within plus or minus a few percentage points of our 2018 performance for adjusted EBITDA.
Our outlook hasn't changed since back in February when we first gave our expectations for the full year.
Overall, the CF team continues to execute exceptionally well.
Asset utilization remains high, and our sales volumes through nine months are new company record.
We also continue to efficiently convert EBITDA into free cash.
Most importantly, we are operating safely.
Our 12-month rolling recordable incident rate at the end of September was 0.17 incidents per 200,000 labor hours, which is a new company record and substantially better than industry benchmarks.
This is a tremendous accomplishment, and we're extraordinarily proud of our team's unwavering focus on safety, particularly in the face of the pandemic.
Speaking of which, our pandemic-related precautionary measures have been working well, and we have not had a single known transmission of the COVID-19 virus within any of our locations.
With these precautions in place, we were able to complete safely critical turnaround activity at several locations during the quarter.
As we look toward next year, the company is well positioned for the opportunities ahead.
As Bert will describe in a few moments, we expect solid global demand and widening energy spreads, which will create greater price realization opportunities during '21 compared to this year.
Given our position at the low end of the global cost curve, we believe these dynamics will support continued strong free cash flow generation.
We are very excited about our announcement last week and our commitment to the clean energy economy, which provides a real growth platform for the company.
As we discussed, hydrogen has emerged as a leading clean energy source to help the world achieve net zero carbon emissions, and ammonia is one of the most efficient ways to transport and store hydrogen.
Because CF is the world's largest producer of ammonia, we are uniquely positioned with our unparalleled asset base and technical knowledge to serve this developing demand.
As we decarbonize our network and aggressively scale our ability to produce green and low-carbon ammonia, we believe we will be able to realize the clean fuel value for ammonia rather than its nutrient value.
In doing so, we expect to realize a substantial premium compared to the value of ammonia as a fertilizer or a feedstock.
Last Thursday, we announced our first steps in seizing this growth opportunity with the green ammonia project at Donaldsonville as the centerpiece of initial investments.
We look forward to sharing our progress and our follow-on steps in the months ahead.
Hen Chris will follow to talk about our financial position and capital allocation before I return for some closing comments.
Year-to-date, the global nitrogen market has been incredibly resilient in light of the pandemic.
Demand for agricultural applications has grown in 2020, and industrial demand continues to recover from the disruptions in April and May.
Looking ahead to 2021, we expect solid global demand led by North America, India and Brazil.
We also project improving price dynamics as the global cost curve steepens with rising energy prices and wider energy spreads compared to North America.
We are forecasting approximately 90 million planted corn acres in the United States in 2021.
This is in line with the levels of the last 10 years and supported by improved farm economics due to higher corn futures, government payments and lower input prices.
If weather conditions allow, we would expect to have a strong fall ammonia season due to the farm economics I just described and the attractiveness of ammonia prices today compared to the other nitrogen products.
We expect that industrial demand will continue to recover in line with economic activity.
We believe industrial demand for ammonia has been mostly tied to the state of the economy due to the pandemic.
In contrast, demand for feed-grade urea and diesel exhaust fluid has been relatively resilient.
Our year-to-date DEF sales volumes are up 6% compared to 2019, which would have been difficult to foresee in April when economic activity and miles driven declined so dramatically.
Outside of North America, we continue to expect positive demand in most growing regions, particularly India and Brazil.
We believe India is likely to exceed nine million metric tons of urea imports through tenders in 2020.
We also expect demand for urea imports into Brazil of approximately 6.5 million metric tons will continue to be supported by improved farm incomes and no active domestic urea production.
As we look at our cost curve projection for the next year on slide 12, we see opportunities for greater price realizations during 2021 compared to this year.
In 2020, the convergence of global natural gas prices in the first half led to a largely flat global cost curve.
Formally, high-cost producers pursued this temporary margin opportunity available to them, increasing operating rates and pressuring product prices.
In recent months, energy prices have risen across the globe but at a much higher rate in Europe and Asia than in North America.
These higher gas costs and the steeper global cost curve that results increases opportunities for low-cost producers like CF to achieve greater price realizations.
Indeed, some of our most profitable years has been when our own natural gas costs were higher but energy spreads were wider.
We are well prepared as the nitrogen market dynamics adjust over the coming year and the direction of the global response to the pandemic becomes clearer.
For the first nine months of 2020, the company reported net earnings attributable to common stockholders of $230 million or $1.07 per diluted share.
EBITDA was $982 million, and adjusted EBITDA was $1 billion.
For the third quarter of 2020, we reported a net loss attributable to common stockholders of $28 million or $0.13 per diluted share.
EBITDA was $196 million, and adjusted EBITDA was $204 million.
As you know, the third quarter typically has our lowest realized prices, lowest volumes and highest level of maintenance and turnaround activity.
This quarter was no different.
However, both our year-to-date and quarterly results reflect the same overall factors: lower year-over-year global nitrogen prices partially offset by lower natural gas and SG&A costs.
On a trailing 12-month basis, net cash provided by operating activities was approximately $1.2 billion, and free cash flow was $756 million.
At the end of October, cash on the balance sheet was well over $600 million, and we are well positioned to fulfill our commitment to repay the remaining $250 million on our 2021 notes.
We expect capital expenditures for 2020 to be approximately $350 million as we maintain our high standards of reliability and safety.
We expect our capital budget will return to our typical $400 million to $450 million range in 2021 and beyond.
Each year, our capital -- capex budget includes not only turnarounds and other sustaining activities, but also investments in improvement projects that allow us to pursue strategic opportunities.
Recent examples from this lighter include the nitric acid expansion project announced this year and the diesel exhaust fluid unit completed in 2017, both at our Donaldsonville facility.
The green ammonia project at Donaldsonville will fit into this improvement portion of our capital expenditure budget over the next three years, which allows us to maintain our overall capex at normal levels.
That said, we expect that additional steps we will take to enable the production of green and low-carbon ammonia will require investment beyond this $400 million to $450 million annual range.
We are excited to invest in the growth of the company given the expected profile -- expected return profile, and we see a lot of opportunities ahead to do just that.
So after the repayment of the $250 million in 2021 notes, we would expect that our primary use of cash in the coming years will be in support of our strategic focus on clean hydrogen and ammonia projects.
With that, Tony will provide some closing remarks before we open the call to Q&A.
Our team continues to demonstrate their focus, operational excellence and the strength of our business during the most unusual of years.
I also want to recognize the winner of our annual Wilson Award for Excellence in Safety.
This year's winner is our Courtright Nitrogen Facility in Ontario for their deployment of wireless technology to better predict and prevent equipment failures.
This award is a great reflection of our safety culture at work, and I encourage everyone to view the impressive ideas from this year's finalists, which can be found on our website.
As the world focuses on decarbonization, hydrogen will be a key clean energy source, and ammonia is a critical enabler for the storage and transport of hydrogen.
CF Industries is the world's largest producer of ammonia, and we will leverage our significant competitive advantages, which include the strength of our team, our operational excellence, technical knowledge and unparalleled asset base, advantages that will enable us to deliver green and low-carbon ammonia at scale years faster and billions of dollars less capital-intensive than many others looking at this opportunity.
This will propel us to the forefront of hydrogen supply, being a leader in producing clean fuels for a sustainable world and providing a growth platform to create shareholder value.
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compname reports nine month 2020 net earnings of $230 million, ebitda of $982 million.
q3 loss per share $0.13.
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I'm Martin Jarosick, Vice President of Investor Relations.
These statements are not guarantees of future performance and will involve risks, uncertainties and assumptions that are difficult to predict.
Therefore, actual outcomes and results may differ materially from what is expressed or implied in any statements.
More detailed information about factors that may affect our performance may be found in our filings with the SEC, which are available on our website.
Now let me introduce Tony Will, our President and CEO.
These results reflect the drastically improving industry fundamentals that we experienced over the course of the year.
Nitrogen prices are at their highest levels in over a decade as strong demand and lower worldwide production have tightened the global supply demand balance considerably.
At the same time, energy spreads between North America and high-cost regions have widened dramatically, supporting margin expansion for our cost advantage network.
The CF team also continues to perform exceptionally well, navigating a couple of severe weather events in the U.S., our highest levels of turnaround and maintenance activity ever, and a challenging natural gas situation in the U.K. Most importantly, they did so safely.
Our recordable incident rate at the end of September was just 0.24 incidents per 200,000 labor hours, significantly better than industry averages.
These factors have driven substantial cash generation over the last year.
Our trailing 12-month net cash from operations was $1.7 billion and free cash flow was $1 billion.
As we look ahead, we're excited about the opportunities to build on this performance.
We have good visibility into the fourth quarter of 2021.
We have priced virtually all of our product shipments through the end of the year while also hedging our natural gas requirements.
While there is always some uncertainty about the volume of ammonia that will be applied in Q4, given the dependency on weather, we would expect full year 2021 adjusted EBITDA to land between $2.2 billion and $2.4 billion.
Further out, we believe nitrogen industry conditions will remain positive for an extended period.
As Bert will describe in a moment, we see very strong demand, constrained global supply and wide energy spreads between North America and Europe to persist for some time.
These factors support our ability to continue to generate significant free cash and to deploy that capital to create shareholder value.
Our priorities remain the same: invest in growth where opportunities offer returns above our cost of capital and return excess capital to shareholders through dividends and share repurchases.
We remain focused on disciplined investments and are excited about the two new projects supporting our clean energy growth platform.
Once completed, these projects will enable us to produce over one million tons of blue or carbon-free ammonia.
Chris will share more about our announcement yesterday in a moment.
We are also pleased to have achieved investment-grade credit ratings, which recognizes and underscores all of the work we have done to remove fixed costs in the business, reduce debt and highlights the positive industry fundamentals for a North American producer.
On the balance sheet, we are quickly closing in on our target of $3 billion of gross debt and expect to repay the remaining $500 million outstanding on our 2023 notes on or before their maturity.
However, that still leaves a substantial amount of excess free cash flow we expect to generate.
And as such, the Board has authorized a new $1.5 billion share repurchase program to facilitate the return of capital to shareholders.
Then Chris will follow to talk about our financial position and clean energy initiatives, before I return for some closing comments.
The last six to nine months have seen a dramatic tightening of the global nitrogen supply and demand balance.
High crop prices and increased economic activity continue to drive demand.
Meanwhile, lower global production and government actions have created a supply constrained global market.
The impact of this can be seen on Slides 11 and 12, where both our spot cost curve and 2022 cost curve are much higher and steeper than in recent years.
As you can see, the margin opportunities available to our network have expanded greatly due to a widened energy spread between North America and marginal production in Europe.
We expect strong global fertilizer demand to last into at least 2023.
As you can see on Slide 8, global stocks-to-use ratios for both grains and oilseeds are at their lowest levels in nearly a decade, supporting high crop prices.
These prices will support farm profitability in North America, even with higher input prices, incentivizing farmers to plant acres and maximize yield.
Based on our order book, we expect the fall ammonia application season will be the largest since 2012, demonstrating farmer commitment to planting corn and applying fertilizer.
We believe farmers around the world will make similar decisions, with import demand continuing to be led by India and Brazil.
We believe global supply will remain constrained in the near term, with relief unlikely to appear anytime soon.
We believe inventory in the channel is very low.
Global production has been lower in 2021 due to severe weather in North America, higher maintenance worldwide, and ongoing European shutdowns and curtailments.
Further, the Russian and Chinese governments are discouraging nitrogen fertilizer exports through the spring.
These factors suggest the potential for strong fertilizer demand to last beyond 2023 even as some regions are unable to secure enough product in this supply constrained environment, resulting in lower yields.
If this were to happen, demand would be deferred into future years as it would take more than two growing seasons to replenish global grain and oilseed stocks.
As we prepare for the spring application season, we continue to receive substantial interest for any product we offer into the marketplace.
We are building a solid order book for the first quarter of 2022 at the prices you see in the market today.
Similar to what we did for the fourth quarter, we are adding natural gas hedges as we make first quarter product commitments in order to lock in margin and protect against significant energy price spikes.
As a result, we believe we're in a strong position heading into 2022.
In this dynamic market, we remain focused on leveraging our manufacturing, distribution and logistics capabilities to serve our customers and look forward to the opportunities before us.
For the first nine months of 2021, the company reported net earnings attributable to common stockholders of $212 million or $0.98 per diluted share.
EBITDA was $984 million and adjusted EBITDA was approximately $1.5 billion.
Net earnings and EBITDA reflect the recognition of a noncash impairment charges related to our U.K. operations.
We continue to monitor market conditions for the U.K. assets, which accounted for two of our gross margin in 2020.
The Billingham complex is operating due to recently improved carbon dioxide contracts and industrial contracts that pass through natural gas costs.
Operations at Ince remain halted.
Free cash flow -- free cash generation remains strong.
The trailing 12 months net cash provided by operating activities was approximately $1.7 billion and free cash flow was $1 billion.
We believe we have a good opportunity in 2022 to build on these results based not only on our positive outlook, but also on increased production from our network.
In 2021, we completed a record level of maintenance activity that included turnarounds at seven of our 17 ammonia plants.
We will return to a more normal level of turnaround activity in 2022.
As a result, we expect to return to our typical high ammonia utilization rates, with gross ammonia production between 9.5 million and 10 million tons.
We expect to sell everything we produce and achieve sales volume between 19 million and 20 million tons in 2022.
As we sell these product volumes into a favorable market environment, we expect to continue to generate substantial free cash flow and create shareholder value.
As Tony said, our Board authorized the new $1.5 billion share repurchase program, which becomes effective January 1, 2022.
We continue to operate under our existing program, which has enabled us to acquire more than 11 million shares to be repurchased since 2019.
This program expires at the end of the year.
At the same time, we'll continue to evaluate clean energy initiatives to meet the demand for ammonia's clean energy capabilities that we expect to emerge in the second half of the decade.
This includes positioning our network for the production of blue and green ammonia to support the development of a market for low-carbon ammonia.
Constructing carbon dioxide dehydration and compression units at Donaldsonville and Yard of the City are a necessary step to enable blue ammonia production through carbon capture and sequestration.
These projects leverage our existing asset base and represented an efficient use of capital, with a return profile we expect to be above our cost of capital.
Once sequestration is initiated, we'll be able to produce more than one million tons of blue ammonia annually while reducing our carbon emissions in a meaningful way.
With our strong balance sheet, we also have the flexibility to evaluate additional opportunities in the years ahead.
We continue to collaborate with global leaders where we can provide value, including jointly exploring with Mitsui the development of blue ammonia projects in the United States.
With that, Tony will provide some closing remarks before we open the call to Q&A.
Their commitment and dedication continue to be the foundation of our success.
We are excited about what lies ahead for CF Industries.
In fact, I think the company is better positioned today than we have ever been in our history.
We are again an investment-grade credit issuer.
We have the fewest shares outstanding ever.
We expect the business to produce between $2.2 billion to $2.4 billion of adjusted EBITDA this year.
And as we look forward to next year, we should have significantly more tons to sell at overall average higher prices than this year.
So the business should generate all-time records for free cash flow per share.
We see demand for low-carbon ammonia developing that should provide a long-term growth platform for the company.
And with our investments in both green and blue ammonia production, we will be at the forefront of this exciting opportunity.
Taken together, we have never been in a better position to create value for shareholders.
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compname reports nine month 2021 net earnings of $212 million, ebitda of $984 million, adjusted ebitda of $1,485 million.
cf industries holdings - management believes global nitrogen supply will remain constrained with production in key regions affected by high energy prices.
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I'm Martin Jarosick, Vice President, Investor Relations for CF.
These statements are not guarantees of future performance and involve risks, uncertainties and assumptions that are difficult to predict.
Therefore, actual outcomes and results may differ materially from what is expressed or implied in any statements.
More detailed information about factors that may affect our performance may be found in our filings with the SEC, which are available on our website.
Now let me introduce Tony Will, our President and CEO.
Before I jump into our financial results, I want to highlight the entire CF team for amazing execution across all areas of our business.
We set all-time company best records for safety, ammonia production and sales volumes, despite the challenges that 2020 hurled at us.
There was no playbook for how to manage through a global pandemic, yet this team developed and implemented plans to keep our people safe along with everyone who came on to our sites.
To date, we have no known transmissions of COVID-19 within any of our facilities.
On the safety front, we ended the year with only four recordable injuries and zero lost time injuries across the entire network for the whole year.
As is typically the case, safe operations are also more productive.
And we proved that again with an all-time ammonia production record of 10.4 million tons.
Our sales and logistics team rose to the challenge and set all-time sales and shipping records of over 20 million product tons.
Truly a remarkable performance by all.
Looking ahead, we are very optimistic about 2021.
As Bert will describe in a moment, the global nitrogen pricing outlook is much more positive than a year ago.
With strong commodity crop prices and significantly higher energy prices in Asia and Europe, we are seeing a robust demand environment, coupled with a steeper global cost curve.
The current conditions in the Southern Plains in Midwest have thrown another crisis at us, but as usual, the team has done a fantastic job responding to and navigating through these new challenges.
We have been able to quickly adjust our plant operations based on close communications with our gas suppliers.
Disruptions have been widespread across the US nitrogen industry and this should result in further tightening of nitrogen supply for the spring planting season in North America, additional support for an already strong 2021.
Longer term, we are pleased with the progress we are making on our commitment to the clean energy economy.
We continue to advance discussions with technology providers and partners, and we have seen new opportunities develop since our announcement.
These underscore how broad the demand for green and low carbon ammonia will be, and also the value of our unique capabilities.
Then Chris will follow to talk about our financial position and capital allocation outlook before I return for some closing comments.
Global nitrogen dynamics today with low-cost producers like CF are the most positive they have been since 2014.
Strong demand driven by high commodity crop prices and a steeper global cost curve are creating a tighter nitrogen supply and demand balance.
As a result, prices have risen significantly in recent months and are well above 2020 values.
Global demand is robust and broad-based.
Farmers in North America has seen nitrogen consuming coarse grains reach multi-year highs for both near term and futures contracts.
For corn, we have seen lower-than-expected supply and high global demand led by China.
As a result, the USDA is projecting that the corn stocks-to-use ratio for the marketing year-over-year will be at its lowest level since 2013.
This supports our projection of 90 million to 92 million planted corn acres in the US this year with upside potential.
Through the balance of the year, we continue to expect positive demand in most growing regions, particularly India and Brazil.
We expect the urea tender volumes in India this year will be well above the five year average and close to the 10 million metric tons of last year.
For Brazil, we project 2021 imports of urea to be approximately 6.57 million metric tons, similar to last year.
As demand was increasing, the cost curve steepened significantly.
From July 2020 to July -- to December 2020, the Dutch TTF natural gas price and the Asian JKM LNG price both increased about five times greater than the US Henry Hub natural gas price.
This had a number of impacts.
First, margin opportunities increased for low cost producers.
Second, the significant increase in energy prices for producers in Europe and Asia pressured their margins, not only leading to lower operating rates but creating demand for import ammonia into those regions.
This contributed to even tighter global market.
Over time, we expect the global nitrogen market to tighten further and faster driven by several factors.
In the near term, the need to rebuild the stock of commodity crops will underpin demand growth.
Longer term, a key driver will be emerging demand for ammonia for clean energy applications.
We believe this level of global demand will require more production from the highest cost plants until prices rise enough to incent greenfield construction in other parts of the world.
We are well positioned as we approach the spring application season and have the flexibility necessary to address any challenges that arise.
We believe that the recent weather conditions in the US, or [Phonetic] disruption that we've built our system to overcome.
We are looking forward to working with our customers and leveraging our optionality to ensure that these requirements are met as they make -- as our customers make their final preparations for spring.
For 2020, the company reported net earnings attributable to common stockholders of $317 million or $1.47 per diluted share.
EBITDA was $1.32 billion and adjusted EBITDA was $1.35 billion.
Net cash provided by operating activities was $1.2 billion and free cash flow was approximately $750 million.
These results reflect year over year, global nitrogen -- lower year-over-year global nitrogen prices, partially offset by higher sales volume and lower natural gas and SG&A costs compared to the year before.
The results also demonstrate our continued efficient conversion of EBITDA into free cash.
As you can see on slide 9, we converted more than 55% of our adjusted EBITDA into free cash in 2020, which is the highest rate among our peers.
Our free cash conversion continues to support our capital structure and allocation priorities.
This will lower our gross debt to $3.75 billion.
As we remain focused on investment grade and positioning the company to execute our clean energy growth strategy, we will continue to evaluate opportunities to further reduce gross debt over time.
We remain excited to invest in the clean energy growth opportunity given the expected return profile.
We will also continue to return cash to our shareholders through our quarterly dividend and opportunistic repurchases at attractive levels.
As we look ahead to 2021, I want to share some of our expectations for the year ahead.
We anticipate that our capital expenditures for 2021 will be in the range of $450 million.
This reflects a return to a normal level of planned maintenance and turnaround activities in the year ahead, and the first expenses associated with the Green ammonia project at Donaldsonville.
We also expect SG&A levels to return to a level closer to 2019 than 2020.
Our annual cash interest expense will fall to $175 million with the repayment of the 2021 notes.
With our planned maintenance schedule and recent gas driven curtailments, we expect gross ammonia production to be around 9.5 million to 10 million tons.
This, along with lower inventories to the start of the year will likely result in lower product tons sold than in 2020.
Additionally, based on forward curves, we project our natural gas costs will be somewhat higher in 2021 than in 2020.
However, we expect margins to improve this year given the positive nitrogen pricing outlook that Bert described.
As you can see on slide 12, increases in our realized urea price have a much greater impact on EBITDA than higher realized natural gas costs.
With that, Tony will provide some closing remarks before we open the call for Q&A.
Their commitment to our values and unwavering focus on safety and execution are truly the foundation of our success.
We feel very positive about the year ahead.
As Bert described, nitrogen industry dynamics for producers in North America are the most favorable we have seen in nearly a decade.
And longer term, the developing demand for ammonia in clean energy applications provides exciting growth prospects for us, where we are uniquely positioned to be a global leader providing clean energy for a better world.
Economies will continue to focus on decarbonization, and hydrogen will be a key solution, with ammonia a critical enabler of hydrogen as a clean fuel.
We have seen tremendous interest in our strategic direction since our announcement last fall, and see substantial opportunities ahead for clean and low carbon ammonia.
This will provide a growth platform for longer-term shareholder value.
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compname reports full year 2020 net earnings of $317 mln.
compname reports full year 2020 net earnings of $317 million, ebitda of $1,316 million, adjusted ebitda of $1,350 million.
projects capital expenditures for full year 2021 will be in range of $450 million.
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I'd like to give you a sense for how Church & Dwight has reacted to the pandemic.
The virus disrupted just about everything.
Consumer behavior, retailer operations, our supply chain and how we work.
We pivoted every aspect of our business to meet the new challenges.
Initially, we had a daily huddle at 8:00 a.m. seven days a week to address employee safety, production levels, co-packer operations and shipment patterns.
Today, we meet five days a week.
We increased our communications with retailers and changed our marketing messages.
We moved people to focus on the online class of trade to create and upload new content.
To speed up our reaction time, we created new data feeds of POS data and retailer in stock levels.
We added more co-packers to our supply chain network.
We conduct weekly surveys of our consumers.
And all of our efforts are paying off.
The agility and resilience of the Church & Dwight team shows up in our results.
Our priorities continue to be employee safety, meeting the needs of consumers and retailers, helping the communities where we live and ensuring the strength of our brands.
Our plant, warehouse and laboratory employees have done an exceptional job in keeping safe, which has contributed to our ability to operate our supply chain.
The rest of our employees are working remotely and doing a super job running the company.
We have been supporting our communities through monetary and product donations, including the contribution of personal protective equipment.
In June, we began producing hand sanitizer in our U.K. plant for both donations and employee usage.
With respect to consumers and retailers, we are taking steps to increase both short and long-term manufacturing capacity, and we continue to work closely with suppliers and retail partners to keep pace with increased demand.
A good example is our installation in Q2 of a new liquid laundry line in our York plant, which was quite a feat given the obstacles presented by COVID.
And as I mentioned before, we've added more co-packers to ensure steady supply for other categories.
Now let's talk about the results.
Q2 was an exceptional quarter.
Reported sales growth was 10.6%.
Gross margin expanded by 220 basis points, and adjusted earnings per share was $0.77.
Revenue, gross margin, earnings and operating cash flow were all significantly higher than Q2 last year, driven by the increase by a significant increase in demand for many of our products.
Organic sales grew 8.4%, driven by higher consumption, restocking of retailer inventories and lower couponing.
Our exceptional first half is a testament to the diverse set of categories that we compete in and the strength of our brands.
Regarding e-commerce, even more consumers have moved online.
Our online sales increased by 75% in Q2 as all retailer.coms have grown.
We began the year targeting 9% online sales.
In Q1, 10% of our sales were online.
In Q2, it was 13%, and we expect second half online sales to be equally strong.
We continue to conduct research on the purchasing habits of U.S. consumers.
Of the categories that we are following, there is continued consumer worry about the ability to leave the house and concern that stores and websites will run out.
Consumers report that they are consolidating shopping trips and continue to stockpile to ensure that they have enough product for a couple of weeks at a time.
Similar to last quarter, I now want to talk about consumption and shipments.
Year-to-date shipment and consumption patterns are back in balance for our brands in the 15 categories that we compete.
We do have some additional opportunities in gummy vitamins and ARM & HAMMER baking soda as shipments are still well behind consumption.
In Q2, we saw a double-digit consumption growth in gummy vitamins, women's hair removal, cleaners and baking soda.
On the other hand, restrictions on consumer mobility drove double-digit consumption declines for WATERPIK, TROJAN condoms and BATISTE dry shampoo.
People are just not socializing due to government restrictions under mobility, which has a big effect on some personal care categories.
July consumption for the U.S. business is tracking to be over 10%, led by our gummy vitamin brands, OXICLEAN additives and baking soda.
1/3 of our July consumption growth is attributed to our gummy business.
In July, and I think this is important, only two of our 15 brands, that would be BATISTE and TROJAN, showed negative consumption.
In contrast, in the month of May, eight of our 15 key product lines showed negative consumption.
So consumption is trending positively.
July shipments for the U.S. business are tracking to be up high single digits.
Shipments of gummy vitamins, OXICLEAN additives, baking soda and WATERPIK are all up double-digit in July.
Our gummy vitamins have been on fire.
Consumption for May, June and July has been averaging up over 40%.
And there is an increased consumer focus on wellness, and it is likely that we will reach a permanently higher level of consumption.
We are looking at third parties to supplement our existing capacity right now.
You may recall that we announced our exit from private label early in Q1, and that turned out to be a timely decision because it helped free up capacity for our brands.
Regarding our laundry and litter businesses, consumption is recovering.
You will recall that there was massive pantry loading in laundry and litter in the month of March.
The laundry pantry loading appears to be absorbed as our consumption improved from being down low single digits in the quarter to up approximately 10% in July year-over-year.
Similarly, ARM & HAMMER litter improved from negative consumption in Q2 to up approximately 5% in July.
So our two big categories are recovering nicely.
In the water flosser category, WATERPIK is starting to recover from the steep decline in April when consumption was down 55%.
Q2 consumption was down significantly due to retailer closures, deprioritization of water flossers by some retailers and closure of dental offices.
Remember that dental professionals are an important source of water flosser recommendations, which influences first-time buyers.
The most recent surveys indicate that 95% of dental offices are now open, although most are at a reduced capacity.
The good news is monthly consumption of WATERPIK water flossers is now positive.
Although our Lunch & Learn activity continues to be significantly curtailed, we intend to address this with incremental advertising in the second half.
The FLAWLESS brand has had strong consumption growth in May, June and July due to reduced consumer access to salons.
The launch of our new full-body device, NU RAZOR, was perfectly timed.
FLAWLESS is one of our brands that could benefit from the at-home grooming trend, and we tend to strongly support FLAWLESS with advertising in the second half.
Private label shares is something we track closely.
As you know, our exposure to private label is limited to five categories, and the private label shares were generally unchanged in Q2, and it was also true in Q1.
Because of the virus, consumer trends are emerging, which affect our business, including a focus on cleaning, personal wellness and new grooming routines.
These consumer trends may endure over the long term, and if they do, we believe we are well positioned.
Our international business came through with slightly positive organic growth in the quarter, driven by strong growth in our GMG business, that stands for Global Markets Group.
In particular, China and Asia-Pacific turned in a remarkably strong performance in the second quarter.
And in July, our GMG business is off to a strong start.
And we're seeing strong POS recovery in Canada and Europe as well is starting to recover.
Our Specialty Products business has had three straight quarters of organic growth, and we expect continued organic growth for our Specialty Products in the second half.
Now turning to new products.
Innovative new products will continue to attract consumers even in this economy.
In Q2, we launched a new ARM & HAMMER laundry detergent called CLEAN & SIMPLE, which has only six ingredients plus water and this compares to 15 to 30 ingredients for the typical liquid detergent, and has the cleaning power comparable to our best-selling consumer favorite, which is ARM & HAMMER with OXICLEAN.
However, because of retailer stocking issues in the second quarter, we eliminated advertising, trade and couponing support that we had planned, and we pushed it to the second half.
We're excited to report today that we have another big product launch this year.
The second launch is in the clumping litter category.
This month, we began shipping ABSORBx, which is a revolutionary new ARM & HAMMER lightweight litter made from desert dry materials.
It absorbs wetness in seconds to trap and seal odors fast.
ABSORBx is 15% lighter than our existing lightweight, and it's 55% lighter than our regular clumping litter.
We have a significant amount of advertising, trade and couponing planned for the second half to get behind this exciting new launch.
And by the way, here's a fun fact, our friends at Clorox just posted to their website a new litter variant called Ultra Absorb.
And we'll take that as a complement.
Imitation is the greatest form of flattery.
Now let's turn to the outlook.
We had an exceptional first half, and we were running well ahead of our original full year earnings per share outlook.
We reinstated our earnings per share outlook with 13% growth, which is far above our evergreen target of 8% annual earnings per share growth.
As in prior years, when we find ourselves in this position, we use the opportunity to invest in our future, which we intend to do in the second half.
You may recall that just last year, we had this exact same opportunity to invest, and our earnings per share was down 4% in Q4 2019 as a result.
This year, we just got to a similar point much earlier.
It's important to note that we continue to take the long view in running Church & Dwight.
Now in conclusion, there are lots of reasons to have confidence in Church & Dwight.
The great thing about our company is we are positioned to do well in both good and bad economic times.
The categories in which we play are largely essential to consumers.
We have a balance of value and premium products.
Our power brands are number one or number two in their categories, and we have low exposure to private label.
We're coming off one of the best first halfs we've ever had and are entering this downturn in a position of strength and with a strong balance sheet.
And with a strong balance sheet, we continue to be open to acquire TSR accretive businesses.
And finally, we have the resources, the common sense and the ambition to ensure that our brands perform well in the future.
And next up is Rick to give you details on the second quarter.
We'll start with EPS.
Second quarter adjusted EPS, which excludes an acquisition-related earn-out adjustment, grew 35% to $0.77 compared to $0.57 in 2019.
The earnings per share increase was largely driven by higher sales due to continued high consumer demand for our products and higher gross margins.
As we discussed in previous calls, the quarterly earn-out adjustment will continue until the conclusion of the earnout period.
Reported revenue was up 10.6%, reflecting a significant increase in consumer demand for our products due to COVID.
Organic sales were up 8.4%, driven by a volume increase of 4.9% and positive product mix and pricing of 3.5%.
Organic sales growth was driven by higher consumption, lower couponing and recovery of retailer and stock levels.
Now let's review the segments.
Organic sales increased by 10.7% due to higher volume and positive price mix.
We typically try to break down the organic growth for you.
6% is consumption growth, reflecting strong, tracked and untracked in e-commerce growth, 1% from lower couponing, and then approximately 3.5% from improving retail and stock levels.
Overall, growth was led by ARM & HAMMER liquid laundry detergent, VITAFUSION and L'IL CRITTERS gummy vitamins, ARM & HAMMER clumping cat litter and baking soda and OXICLEAN stain fighters.
Consumer International delivered 0.6% organic growth due to positive price and product mix offset by lower volume.
Growth was driven by BATISTE Dry shampoo, FEMFRESH feminine hygiene portfolio and ARM & HAMMER liquid laundry detergent, launch detergents in the Global Markets Group business, partially offset by Europe and Mexico domestic market declines.
Of note, Asia-Pacific had strong performance in the quarter.
For our SPD business, organic sales increased 3% due to higher volume, offset by lower pricing.
And demand for our products continues to grow in the poultry industry.
Turning now to gross margin.
Our second quarter gross margin was 46.8%, a 220 basis point increase from a year ago due to a reduction in trade, couponing and improved productivity.
In terms of the gross margin bridge versus year ago, positive price and volume and mix contributed 220 basis points.
Productivity added 140 basis points, offset by higher manufacturing costs of 110 basis points which was driven by 110 basis points related to COVID supply chain costs and then improved commodity costs were offset by higher manufacturing costs.
Finally, a drag of 20 basis points from the prior year FLAWLESS accounting impact and a 10 basis point drag from FX is how we get to 220 up for the quarter.
Moving now to marketing.
Marketing was down $6.8 million year-over-year.
Marketing expense as a percentage of net sales decreased 180 basis points to 10.2%.
Due to retailer out of stocks, marketing spend was significantly reduced and shifted to the back half to support new products.
For SG&A, Q2 adjusted SG&A increased 30 basis points year-over-year, primarily due to higher incentive comp, intangible costs related to acquisitions and investments in R&D and IT.
And for net operating profit, the adjusted operating margin for the quarter was 21.5%.
Other expense all in was $14.7 million, a slight decline due to lower interest expense resulting from lower interest rates.
And for income tax, our effective rate for the quarter was 19.6% compared to 18.7% in 2019, an increase of 90 basis points, primarily driven by lower stock option exercises.
And now turning to cash.
For the first six months of 2020, cash from operating activities increased 70% to $599 million due to higher cash earnings and a decrease in working capital.
This includes deferring an $81 million income tax payment in line with the CARES Act.
Within the quarter, we fully repaid the revolving credit line that was accessed in Q1 during the early days of COVID.
As of June 30, cash on hand, was $452 million.
Our full year capex plan has gone from $80 million to $100 million as we begin to expand manufacturing and distribution capacity, primarily focused on laundry, litter and vitamins.
And now turning to the outlook.
Company is now reinstating the 2020 outlook, given we have half the year behind us and strong sales growth in July.
However, due to quarterly volatility in retailer orders and consumer consumption, we will only provide a full year outlook.
We now expect approximately 9% to 10% full year 2020 sales growth and approximately 7% to 8% organic sales growth.
Adjusted earnings per share growth is expected to be 13% above the high end of our original 7% to 9% outlook.
This implies a front-end loaded year and flat earnings per share in the second half as the company has shifted promotional and advertising dollars from the first half to the second half in support of new products.
Turning to gross margin.
The first half gross margin expanded 150 basis points.
We expect that second half will contract by a similar amount.
Half of it is simply the year-over-year impact of acquisition accounting.
The balance reflects incremental COVID costs as well as WATERPIK tariffs, new product support that Matt mentioned, incremental manufacturing and distribution capacity investments.
And so net, that means we'll be slightly below our original full year margin outlook.
As you heard from Matt, we intend to make incremental investments in the back half of 2020.
Some examples here include a new third-party logistics provider, outside storage to handle surge inventories.
Preliminary engineering on capacity decisions.
VMS outsourcing costs as well as other investments around automation, consumer research and analytics.
Lastly, consistent with how we've been managing throughout the crisis, our outlook may continue to adapt, and we may continue to defer trade couponing in advertising even into next year, depending on consumption, the resurgence of COVID-19 or supply constraints.
And with that, Matt and I would be happy to take any questions.
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compname reports q2 adjusted earnings per share $0.77 excluding items.
q2 adjusted earnings per share $0.77 excluding items.
2020 full year outlook raised from original outlook.
2020 reported sales growth forecast raised to 9-10%.
2020 organic sales growth forecast raised to 7-8%.
2020 adjusted earnings per share growth forecast raised to 13%.
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But before we begin, I'd like to recognize all Church & Dwight employees around the world for their continued dedication to keeping our company going during the pandemic, especially our supply chain and R&D teams as during this quarter the company faced the complexities of raw material shortages and labor shortages at our suppliers and third-party manufacturers.
Now let's talk about the results.
Q2 was another solid quarter for the company.
Reported sales growth was 6.4%, organic sales growth -- grew 4.5% and exceeded our 4% Q2 outlook.
The 4.5% organic growth is impressive considering Q2 2020 organic sales growth was 8.4%.
Adjusted earnings per share was $0.76 and that's $0.07 better than our outlook.
The earnings per share beat is attributed to two things, one, a temporary reduction in marketing, and two, our revenue growth handily exceeded our outlook.
Another item that is noteworthy is we overcame a tax rate which was much, much higher than expected in Q2.
We grew consumption in 13 of the 16 categories in which we compete, and in some cases on top of big consumption gains last year.
Another way to look at this is to compare our Q2 consumption on those 16 categories to 2019, a pre-COVID year, we have higher consumption in 14 of those 16 categories compared to Q2 2019.
Regarding brand performance, nine of our 13 brands saw a double-digit consumption growth and I'll name them for you: gummy vitamins, stain fighters, cat litter, condoms, battery powered toothbrushes, depilatories, dry shampoo sailing spray and water flossers.
Now although many of our brands delivered double-digit consumption growth it is not reflected in our 4.5% organic sales growth as shipments were constrained by supply issues which we do expect to lessen by Q4.
In Q2, online sales as a percentage of total sales was 14.2%.
Our online sales increased by 7% year-over-year.
But remember, this is on top of the 75% growth in e-commerce that we experienced in Q2 2020 versus '19.
We continue to expect online sales for the full year to be 15% as a percentage of total sales.
With 70% of American adults having at least one vaccine shots so far, the US has been opening up consumers becoming more mobile.
In recent days however, it appears that trend could slow down due to the delta variant combined with many people still being unvaccinated.
Outside the US, many countries continue to enforce periodic lockdowns and we expect that to continue.
As described in the release we faced shortages of raw and packaging materials.
Labor shortages at suppliers and third-party manufacturers have reduced their ability to produce.
And transportation challenges have further contributed to supply problems.
Besides shortages, we are dealing with inflation.
Significant inflation of material and component costs is affecting our gross margin expectations, which Rick will cover in his remarks.
Due to a lower case fill rate we pulled back on Q2 marketing, especially for household products.
We expect the supply issues to begin to abate in Q4.
The higher input costs and transportation costs are expected to continue though for the rest of the year.
On past earnings calls we described how we expected categories and brands to perform in 2021.
Overall, our full year thinking is generally consistent.
To name a few categories, demand for vitamins, laundry additives, and cat litter is expected to remain elevated in 2021.
Condoms, dry shampoo, and water flosses are recovering and experiencing year-over-year growth as society opens up and consumers have greater mobility.
Baking soda and oral analgesics are expected to decline from COVID highs.
Now I'm going to talk about the divisions.
Consumer Domestic business grew organic sales 2.8%.
This is on top of 10.7% organic growth in Q2 2020.
Looking at market shares in Q2, five out of our 13 power brands met or gained share.
Our share results are clearly impacted by our supply issues.
I'll comment on a few of the brands right now.
VITAFUSION gummy vitamins saw great consumption growth in Q2, up 10%.
Consumers have made health and wellness a priority.
It appears that new consumers are coming into the category and they're staying.
So here's a supporting statistic.
In the last year, VITAFUSION household penetration is up 17%.
That means the brand is now in one out of every ten households.
Next up is WATERPIK.
WATERPIK grew consumption 72% in Q2 as it continues to recover from COVID lows and benefits from the heightened consumer focus on health and wellness.
WATERPIK is also benefiting from dental offices returning to pre-COVID patient levels.
We expect the frequency of our Lunch 'n Learn program to return to normal levels in the second half of this year.
BATISTE dry shampoo grew consumption 37%.
Dry shampoo is recovering as stores have reopened and consumers are becoming more mobile.
Similarly TROJAN delivered 11% consumption growth.
Society has been opening up.
As restaurants, bars and clubs have reopened people are hooking up again.
Here's a fun fact that might be a contributing factor.
In Q2, TROJAN launched on TikTok with explosive uptick from consumers with over 47 million views.
Next I want to discuss International.
Despite intermittent lockdowns in our markets, our international business came through with 10.4% organic growth in the quarter, primarily driven by our strong growth in our Global Markets Group.
Asia continues to be a strong growth engine for us.
WATERPIK, BATISTE, and ARM & HAMMER led the growth for the international division in the quarter.
Our Specialty Products business delivered a positive quarter with 11.8% organic growth.
This was driven by higher pricing and volume.
Milk prices remain stable and demand is high for our nutritional supplements.
At the prior year quarterly organic growth for specialty products was 3%.
So 11.8% is an impressive result.
Now, turning to new products.
Innovative new products will continue to attract consumers.
In the household products portfolio, we introduced OXICLEAN laundry and Home sanitizer.
It's the first and only sanitizing laundry additive that boost stain fighting and eliminates 99.9% of bacteria and viruses.
In the personal care portfolio, VITAFUSION launched Elderberry gummies, Triple immune gummies, and Power Zinc gummies to capitalize and increased consumer interest in immunity.
WATERPIK launched WATERPIK ION, a water flosser which is 30% smaller with a long lasting lithium-ion battery.
It is specifically designed for smaller bathrooms spaces.
To capitalize on its earlier success, WATERPIK SONIC FUSION, the world's first flossing toothbrush was upgraded to SONIC FUSION 2.0 with two brush head sizes and two speeds, and that's doing extremely well.
And finally, FLAWLESS is taking advantage of the at-home beauty and self-care trends with at home manicure and pedicure solutions.
Now let's turn to the outlook.
Since we last spoke to you in April, unplanned cost inflation has grown by another $35 million.
In addition to the price increases on 33% of our portfolio that we announced in April, we have just announced price increases on other categories, which means we have now priced up 50% of our portfolio.
Of course there is a lag in the positive impact of these increases which impacts our earnings outlook.
We now expect to be at the lower end of our range of adjusted earnings per share growth of 6% to 8% as a result of heightened input costs.
Although we expect to be at the low end of the range, it's really important to remember that we are comping 15% earnings per share growth in 2020.
We expect full year reported sales growth of 5% with 4% full year organic sales growth.
It's also important to call out that we are committed to maintaining the long-term health of our brands by ensuring sustained high levels of marketing investment in the second half.
In conclusion, July consumption continues to be strong.
We are navigating through significant supply challenges and cost inflation.
We believe we are well positioned for 2022 with the pricing actions we have taken.
We expect our portfolio of brands to do well both in good and bad times and in uncertain economic times such as now.
We have a strong balance sheet and we continue to hunt for TSR accretive businesses.
Next up is Rick to give us details on Q2.
We'll start with EPS.
Second quarter adjusted EPS, which excludes the positive earn-out adjustment was $0.76, down 1.3% to prior year.
And as we discussed in previous calls, the quarterly earn out adjustment will continue until Q4, which is the conclusion of the earn out period.
$0.76 was better than our $0.69 outlook primarily due to continued strong consumer demand for many of our products as well as a temporary reduction in marketing spend as supply chain shortages were impacting customer fill rates, which we expect to recover in Q4.
The $0.76 includes a $0.04 drag from a higher tax rate and a $0.04 drag from the VMS recall costs.
Reported revenue was up 6.4%.
Organic sales were up 4.5% driven by a volume increase of 4.3%.
Matt covered the topline and I'll jump right into gross margin.
Our second quarter gross margin was 43.4%, a 340 basis point decrease from a year ago.
This was right in line with our outlook for down 350 basis points for the quarter.
Gross margin was impacted by a 480 basis points of higher manufacturing costs primarily related to commodities, distribution, and labor costs.
Tariff costs negatively impacted gross margin by an additional 50 basis points.
These costs were partially offset by a positive 40 basis point impact from price volume mix and a positive 140 basis point impact from productivity programs as well as a ten basis point positive impact from currency.
Moving to marketing, marketing was down $5.3 million year-over-year as we lowered spend to reduced demand until fill rates could recover.
Marketing expense as a percentage of net sales decreased 100 basis points to 9.2%.
We continue to expect full year marketing expense as a percentage of net sales to be approximately 11.5% in line with historical averages.
For SG&A, Q2 adjusted SG&A decreased 140 basis points year-over-year with lower legal costs and lower incentive comp.
Other expense all in was $11.4 million, a $3.3 million decline to the lower interest expense from lower interest rates.
And for income tax, our effective rate for the quarter was 24% compared to 19.6% in 2020, an increase of 440 basis points, primarily driven by lower stock option exercises.
You will hear in a minute this also impacts our full year tax rate.
And now to cash.
For the full -- for the first six months of 2021 cash from operating activities decreased 42% to $344 million due to higher cash earnings being offset by an increase in working capital.
Accounts payable and accrued expenses decreased due to the timing of payments.
As a reminder, in the year-ago numbers there was an $80 million benefit in Q2 related to the timing of US federal income tax payments shifting from the second to the third quarter in the prior year.
We expect cash from operations to be approximately $90 million for the full year.
As of June 30th, cash on hand was $149.8 million.
Our full year CapEx plan is now $140 million as we continue to expand manufacturing and distribution capacity, primarily focused on laundry, litter, and vitamins.
The decrease from our previous $180 million is project timing related.
For Q3 we expect reported sales growth of approximately 3%, organic sales growth of approximately 1.5% entirely due to supply chain constraints.
We expect gross margin expansion in the quarter led by our price increases.
Adjusted earnings per share is expected to be $0.70 per share, flat from the last year's adjusted EPS.
A strong operating performance is offset by higher tax rate.
And now for the full-year outlook, we now expect full-year 2021 reported sales growth to be approximately 5%, organic sales growth to be approximately 4%.
Our consumption is strong and outpacing shipments.
We expect our customer fill level to improve by Q4.
Turning to gross margin, we now expect full year gross margin to be down 75 basis point.
This represents an incremental impact from our last guidance due to broad based inflation on raw materials and transportation costs.
Our April outlook expected gross margin to be flat for the year, and $90 million of inflation from our original guidance.
Now we're absorbing $125 million of incremental costs for the full year.
This additional $35 million of inflation drives the change in our gross margin outlook.
We've taken another round of pricing actions with over 50% of our global brands having announced price increase.
While some of this benefit helps the second half of 2021, most of the benefit is in 2022.
As a reminder, we price to protect gross profit dollars, not necessarily margin.
The $35 million movement versus our previous outlook is primarily non-commodity related, transportation, labor, third-party manufacturers, and other raw material price increases make up the majority.
Commodities are also up.
And while we have 80% of our commodities hedged, let me give you a sense of what's going on with major commodities.
Over the past few months, second half expectations for resins have moved up considerably.
For example, previously in our forecast it was based on HDPE being up 30% in the second half of the year, now it's up 60%.
Polypros [Phonetic] moved from being up 40% to now 90%.
In addition, transportation costs such as diesel have continued to rise.
We previously expected second half diesel to be up 18% and now it's of 27%.
Cartons and corrugate previously were single digit, now they're low double digit.
So that's the latest Bank [Phonetic] on commodities and now we'll move to tax.
Our full year tax rate expectations are now 23%, higher versus our last expectations due to lower stock option exercises.
This is a $0.04 drag versus our previous outlook.
We now expect adjusted earnings per share to be at the lower end of our previous range of 6% to 8%.
Our brands continue to go from strength to strength as strong consumption in organic sales growth lapped almost 10% organic growth a year ago.
While inflation is broad based, we have taken pricing actions to mitigate, which gives us confidence in margin expansion in the back half.
And with that, Matt.
And I would be happy to take any questions.
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church & dwight co q2 adjusted earnings per share $0.76 excluding items.
q2 adjusted earnings per share $0.76 excluding items.
sees fy sales up about 5 percent.
sees 2021 adjusted earnings per share now at lower end of 6-8% range.
expect q3 net sales to be comparable to q2 net sales.
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The pandemic has given us an opportunity to display our agility as a company.
We increased our communications with retailers.
We changed our marketing messages.
We shifted investments to categories that are most important to consumers.
And we set new production records for VITAFUSION, ARM & HAMMER laundry and ARM & HAMMER baking soda.
And we've moved people to focus on the online class of trade.
So we've been proactive in seizing the opportunities presented by the crisis and are increasing manufacturing capacity in our plants and externally with new co-packers.
The agility and resilience of the Church & Dwight team is showing up in our results.
Our priorities continue to be employee safety, meeting the needs of consumers and retailers, helping the communities where we live and ensuring the strength of our brands.
Our plant, warehouse and laboratory employees have done an exceptional job in keeping safe, which has contributed to our ability to operate our supply chain.
Our office employees continue to work remotely and are doing a super job running the company.
So now let's talk about the results.
Q3 was another exceptional quarter.
Reported sales growth was 13.9% and adjusted earnings per share was $0.70.
Revenue, earnings and operating cash flow were all significantly higher in Q3 than last year, driven by the significant increase in demand for many of our products.
Organic sales grew 9.9%, driven by higher consumption.
Regarding e-commerce, we were already strong pre-COVID and well positioned online.
In Q3, our online sales increased by 77% as all retailer.coms have grown.
One example would be gummy vitamins.
In 2019, 8% of our full year sales were online.
This year, we expect full year to be about 14% online.
Recall, we began the year targeting 9% online sales as a percentage of global consumer sales.
In Q1, it was 10% online; Q2, 13%; and Q3, also 13%.
So we expect the full year to be actually close to 13% as well.
We continue to conduct research on the purchasing habits of U.S. consumers.
There's no surprises here, actually.
There is continued consumer concern that stores will run out of stock and websites will face delivery issues.
Consumers report that they are consolidating shopping trips and continue to stockpile to ensure that they have enough product for a couple of weeks at a time.
If we look at year-to-date shipment and consumption patterns, our brands remain generally in balance in the 15 categories in which we compete.
With respect to our brands, we had broad-based consumption growth in Q3.
We saw a double-digit consumption growth in VITAFUSION and L'IL CRITTERS gummy vitamins, ARM & HAMMER baking soda, OXICLEAN, FLAWLESS, ORAJEL, NAIR, FIRST RESPONSE pregnancy kits and cleaners.
In Household, our laundry business consumption was up 4% and ARM & HAMMER cat litter was up 8%.
Water flossers is another bright spot as consumption turned slightly positive in Q3.
Although our Lunch & Learn activity continues to be significantly curtailed, we intend to continue to address this with incremental advertising.
In addition to VITAFUSION and L'IL CRITTERS, water flossers is another brand we expect to benefit from the heightened consumer focus on health and wellness.
BATISTE dry shampoo remains impacted by social distancing, with consumption down 10%, but improved sequentially compared to Q2 when consumption was down 22%.
TROJAN consumption was down 6% in Q3, but also improved sequentially when we were down 15% in Q2.
There's no doubt that consumers have made health and wellness a priority.
VITAFUSION and L'IL CRITTERS gummy vitamins saw the greatest consumption growth of any of our categories in Q3, up 49%.
The category consumption was even higher.
Our expectation is that consumer demand for gummy vitamins will remain high.
And we have new third-party capacity coming online in late Q4 to take advantage of this trend.
Consumers are focusing on health and wellness, but also, cleaning, home cooking and new grooming routines.
At a recent investor conference, you may have heard me cite consumer research that suggests it takes 66 days to form a new habit.
And only time will tell if all of these new behaviors will translate into permanently higher levels of consumption.
But if they do endure over time, we believe we are well positioned.
Now a few words about private label.
As you know, our exposure to private label is limited to five categories.
Private label shares have remained generally unchanged for the first, second and third quarters of this year.
Our international business came through with double-digit organic growth in the quarter, driven by strong growth in our GMG business, that's our Global Markets Group, and Canada.
In October, our GMG business is off to another strong start, and we continue to see strong POS recovery in Canada and Europe.
After three consecutive quarters of growth, our Specialty Products business contracted 3.4% in Q3, primarily due to the poultry segment.
Now turning to new products.
Innovative new products will continue to attract consumers even in this economy.
VITAFUSION gummy vitamins launched a number of new products.
And to capitalize on increased consumer interest in immunity, we launched POWER ZINC and Elderberry gummies.
We've launched ARM & HAMMER CLEAN & SIMPLE, which has only six ingredients plus water compared to 15 to 30 ingredients for typical liquid detergents.
And in the second half, we launched ARM & HAMMER ABSORBx clumping cat litter, a new litter, which is 55% lighter than our regular litter.
Now let's turn to the outlook.
We're having an exceptional year.
We now expect full year adjusted earnings per share growth of 13% to 14%, which is far above our evergreen target of 8% annual earnings per share growth.
Given our strong performance, we have raised our full year outlook for sales growth to be approximately 11% and organic sales growth to be approximately 9%.
As mentioned many times in the past, we take the long view in managing Church & Dwight in order to sustain our evergreen model.
In the second half, we took the opportunity to increase our marketing spend behind our new products and we made incremental investments in the company.
As we wind up the year, we are putting together our 2021 plan.
It's safe to say that we have a high degree of confidence that we will meet our evergreen model in '21.
In February, we'll provide our detailed outlook for next year.
Now in conclusion, I would like to remind everyone of the many reasons to have confidence in Church & Dwight.
The great thing about our company is we are positioned to do well in both good and bad economic times.
The categories in which we play are largely essential to consumers.
And we have a few categories that stand to benefit from the current environment.
We have a balance of value and premium products.
Our power brands are number one or number two in their categories.
And we have low exposure to private label.
We're coming off some of the best growth quarters we've ever had.
And with a strong balance sheet, we continue to be open to acquiring TSR-accretive businesses.
We believe our company is stronger and more agile than ever.
And finally, we have the resources, the common sense and the ambition to ensure that our brands perform well in the future.
Next up is Rick to give you details on the third quarter.
We'll start with EPS.
Third quarter adjusted EPS, which excludes an acquisition-related earnout adjustment, grew 6.1% to $0.70 compared to $0.66 in 2019.
As we discussed in previous calls, the quarterly earnout adjustment will continue until the conclusion of the earnout period.
Stronger-than-expected sales performance allowed the company to spend incrementally on marketing.
Reported revenue was up 13.9%, reflecting a continued increase in consumer demand for our products.
Organic sales was up 9.9%, driven by a volume increase of 10.2%, partially offset by 0.3% of unfavorable product mix and pricing, primarily driven by new product support.
Volume growth was driven by higher consumption.
Now let's review the segments.
Organic sales increased by 10.7%, largely due to higher volume.
Overall, growth was led by VITAFUSION and L'IL CRITTERS gummy vitamins, WATERPIK oral care products, ARM & HAMMER liquid laundry detergent and OXICLEAN stain fighters.
We commonly get asked to bridge the Nielsen reporting to our organic results.
This quarter, tracked consumption was 7.7% for our brands compared to an organic sales increase of 10.7%.
In this environment, one might assume that is restocking retailer inventory.
That is not the case.
We had 400 basis points of help from strong growth in untracked channels, primarily online, and 100 basis point drag from couponing to support new products.
The good news is, as you heard from Matt, consumption and shipments are in balance, both low double digits.
Consumer International delivered 11.6% organic growth due to higher volume, offset by lower price and product mix.
This was a great recovery for our international business from a flat Q2.
Growth was primarily driven by the Global Markets Group and Canada.
For our SPD business, organic sales decreased 3.4% due to lower volume, offset by higher pricing.
The lower volume was primarily driven by the nondairy animal and food production in sodium bicarbonate business.
Turning now to gross margin.
Our third quarter gross margin was 45.5%, 110 basis point decrease from a year ago.
Gross margin was impacted by 110 basis point drag from tariffs and a 90 basis point impact from acquisition accounting.
In addition, to round out the Q3 gross margin bridge is a plus 100 basis points from price/volume mix; plus 160 basis points from productivity programs, offset by a drag of 80 basis points of higher manufacturing costs, inflation and higher distribution costs; as well as a drag of 90 basis points for COVID costs.
Moving now to marketing.
Marketing was up $45.7 million year-over-year as we invested behind our brands.
Marketing expense as a percentage of net sales increased 230 basis points to 13.8%.
For SG&A, Q3 adjusted SG&A decreased 30 basis points year-over-year, primarily due to leverage from strong sales growth.
Other expense all in was $12.3 million and $3.9 million decline due to lower interest expense from lower interest rates.
And for income tax, our effective rate for the quarter was 17.3% compared to 21.6% in 2019, a decrease of 430 basis points, primarily driven by higher tax benefits related to stock option exercises.
And now turning to cash.
For the first nine months of 2020, cash from operating activities increased 29% to $798 million due to significantly higher cash earnings and an improvement in working capital.
As of September 30, cash on hand was $549 million.
Our full year capex plan continues to be approximately $100 million as we begin to expand manufacturing and distribution capacity, primarily focused on laundry, litter and vitamins.
As I mentioned back at the Barclays conference in September, we do expect a step-up in capex over the next couple of years to approximately 3.5% of sales for these capacity-related investments.
In addition, as you read in the release, due to the strong cash position, the company may resume stock repurchases in the future.
For Q4, we expect reported sales growth of approximately 9%, organic sales growth of approximately 8%.
And as Matt mentioned, we have strong consumption across many of our categories.
Turning to gross margin.
We previously called 150 basis point contraction in the second half.
Now we're saying down 190 basis points.
The change is primarily due to nonrecurring supply chain costs.
We also expect significant expense, and we have called flat for the year in terms of a percent of sales, which implies a step-up in Q4.
We also anticipate a lower tax rate.
As a result, we expect Q4 adjusted earnings per share to be $0.50 to $0.52 per share, excluding the acquisition earnout adjustment as we exit 2020 with momentum.
And now for the full year outlook, we now expect approximately 11% for the year 2020 sales growth, which is above our previously 9% to 10% range.
We're also raising our full year organic sales growth to approximately 9%, up from our previous 7% to 8% outlook.
We raised our cash from operations outlook to $975 million, which is up 13% versus year ago.
Turning to gross margin.
We expect gross margin to be down 20 basis points for the year, primarily due to the impact of acquisition accounting, COVID costs, incremental manufacturing and distribution capacity investments and the higher tariffs on WATERPIK.
As to tariffs, remember back in 2018, we got caught up in Tier two tariffs for which we were granted an extension in 2019.
That exemption expired and was not extended as of Q3 2020.
We continue to work on mitigating that impact.
Another word or two on gross margin.
Previously, I have said the first half of the year was plus 150 basis points on gross margin and the second half was down 150 basis points on gross margin.
And so our outlook as of last quarter was flat for the year.
And then also last quarter, you heard me walk through investments we were making in the second half of 2020.
Examples here included a new third-party logistics provider, outside storage to handle surge inventories, preliminary engineering on capacity, VMS outsourcing costs as well as other investments around automation, consumer research and analytics.
Now we're calling down 190 basis points for the back half or down 20 basis points for the year, and that implies down 250 basis points for the quarter.
We have some supply chain nonrecurring costs.
Here are a few examples.
First, because of our outsized growth, I mentioned last quarter, we're adding a new 3PL distribution center.
In the quarter, we again had stronger sales.
And as such, had duplicative outside storage locations and the new 3PL distribution center that wasn't operational.
So for a period of time, we had duplicative costs.
We're also in the process of going through make first buy decisions.
And that will trigger a couple of asset write-offs likely in Q4.
We have lean training across the plants.
And finally, due to the great results this year, higher incentive comp cost that flow through COGS.
So our full year tax rate expectations are 19%, and we also raised our adjusted earnings per share growth to 13% to 14%.
Now that we're through the outlook, I also want to spend a minute on FLAWLESS.
As you saw in the release, we had an earnout benefit of approximately $50 million in the quarter in reported earnings.
We exclude any of the earnout movements in adjusted EPS.
Some color on that swing.
As a backdrop, we bought that business for $475 million upfront and a $425 million earnout tied to year-end 2021 sales.
That sales target represented in excess of 15% CAGR for three years off of a baseline of $180 million of trailing sales.
The revised 3-year CAGR for this business is closer to 8%.
And as such, the earnout liability comes down and earnings go up.
We're still positive on this business.
And the strong consumption growth these past six months is a great indicator for the future.
As you heard from Matt, the company is well positioned as we enter 2021.
And with that, Matt and I would be happy to take any questions.
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q3 adjusted earnings per share $0.70 excluding items.
sees q4 sales up about 9 percent.
sees 2020 reported sales growth raised to 11%.
2020 organic sales growth raised to 9%.
2020 adjusted earnings per share growth raised to 13%-14%.
2020 cash from operations raised to $975 million.
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But before we begin, I would like to recognize all Church & Dwight employees around the world for their continued dedication to keeping our company going, especially our supply chain and R&D teams as during this quarter, the company faced the complexities of widespread raw material and labor shortages at our suppliers and at our third-party manufacturers.
Now let's talk about the results.
Q3 was a solid quarter.
Reported sales growth was 5.7%, organic sales growth grew 3.7% and exceeded our 1.5% Q3 outlook.
The 3.7% organic growth rate in the quarter is impressive, considering the prior year Q3 2020 organic sales growth was 9.9%.
So that's growth on top of growth.
The adjusted earnings per share was $0.80, and that's $0.10 better than our outlook.
We grew consumption in 12 of the 16 categories in which we compete, and in some cases, on top of big consumption gains last year.
Regarding brand performance, five of our brands saw a double-digit consumption growth, and I'll name them for you: vitamins, ARM & HAMMER cat litter, Scent Boosters, BATISTE and ZICAM.
And although many of our brands experienced double-digit consumption growth, it's not all reflected in our 3.7% organic sales growth as shipments were constrained by supply issues.
In Q3, online sales as a percentage of total sales was 14.3%.
Our online sales increased by 2% year-over-year.
Now keep in mind, this is on top of 100% growth in e-commerce that we experienced in Q3 2020 versus 2019.
And we continue to expect online sales for the full year to be above 15% as a percentage of total sales.
Now as described in the release, Hurricane Ida's impact was substantial, which resulted in limited availability of raw materials and caused our fill levels to continue to be below normal.
Labor shortages at suppliers and third-party manufacturers have constrained their ability to produce.
Transportation challenges have further contributed to supply problems.
Now the good news is that over the past 18 months, we have made our supply chain more resilient by qualifying dozens of new suppliers and co-packers, which provides, of course, both short-term and long-term benefits.
And in a few minutes, Rick will tell you about our plans to expand capacity in 2022, with a significant increase in capex next year to support our growth plans.
Now due to the lower than normal case fill rate, we pulled back on Q3 marketing compared to the prior year, and we expect the supply issues to begin to abate in the first half of 2022.
Our biggest issue is widespread inflation.
We're dealing with significant inflation of raw and packaging materials, labor, transportation and component costs which is compressing our gross margin.
These conditions are expected to continue well into 2022, and Rick will cover gross margin in his remarks in a few minutes.
On past earnings calls, we described how we expected categories to perform in 2021.
Overall, our full year thinking is generally consistent.
Just to name a few categories, demand for vitamins, laundry additives and cat litter has remained elevated in 2021.
The condoms, dry shampoo and water flosser categories have recovered and are experiencing year-over-year growth as society opens up and consumers have greater mobility.
Baking soda and oral analgesics have declined from COVID highs as expected.
So now I'm going to talk about each business.
First up is Consumer Domestic.
So the Consumer Domestic business grew organic sales 2.8%, and this is on top of 10.7% organic growth in Q3 2020.
Looking at market shares in Q3, six of our 13 power brands gained share, and our share results are clearly impacted by our supply issues.
I will comment on a few of the brands right now.
Vitafusion gummy vitamins saw a huge consumption growth in Q3, up 24%.
Consumers have made health and wellness a priority.
It appears that the new consumers that came into the category are staying, because if we look at the last year, Vitafusion household penetration is up almost 10%.
Batiste dry shampoo grew consumption 36% in the quarter and grew share to over 40%, first time that's happened.
Dry shampoo is recovering as stores have reopened and consumers are becoming more mobile.
Next up is Waterpik.
Waterpik consumption declined in the quarter due to the year-over-year timing of a major online retailer sales event.
But the good news is that Waterpik continues to have strong consumption year-to-date and continues to benefit from the heightened consumer focus on health and wellness.
In Household Products, ARM & HAMMER liquid laundry held share despite leading with price.
ARM & HAMMER scent boosters continue to gain share, going the other way was unit dose share, which declined due to supply issues.
The good news in unit dose is that we are now self-reliant with reliable in-house production.
And also in household products, ARM & HAMMER cat litter grew consumption 11%, while gaining 50 basis points of market share.
Next up is International.
Despite disruptions due to COVID, our International business came through with 2.3% organic growth, primarily driven by strong growth in the Global Markets Group.
Asia continues to be a strong growth engine for us.
STERIMAR, FEMFRESH, Vitafusion and L'il Critters led the growth for the International business.
Now the next one is Specialty Products.
Our Specialty Products business delivered a very strong quarter with 18.5% organic growth, but this was on an easy comp.
The prior year quarterly organic growth for Specialty Products was actually down 3.4%.
So 18.5% is a really nice rebound.
And this was driven by both higher pricing and volume.
Milk prices remained stable and demand is high for our nutritional supplements.
Now let's talk about pricing.
In response to the rising costs, we have already taken pricing actions in 50% of our portfolio, effective July one and October 1.
The volume elasticities have been slightly better than expected since the July price increases.
We will be announcing pricing actions effective Q1 2022 on an additional 30% of the portfolio.
That means that as of Q1 2022, we expect to have raised price on approximately 80% of our global portfolio of brands.
Due to our expectation of incremental cost increases, we continue to analyze additional pricing actions that can be put in place next year in 2022.
Now let's turn to the outlook.
Significant inflation of material and component costs and co-packer costs impacted our gross margin in Q3.
Looking forward, we expect input costs and transportation costs to remain elevated in Q4 and we expect significant incremental cost increases in 2022.
Our earnings per share expectations are unchanged.
We expect adjusted earnings per share growth of 6% this year.
It's important to remember that we are comping 15% earnings per share growth in 2020.
We expect full year reported sales growth of 5.5%, with 4% full year organic sales growth.
It's also important to call out that we are committed to maintaining the long-term health of our brands by ensuring a healthy level of marketing investment in Q4 and in 2022.
As many of you know, we typically target 11% to 12% marketing spend.
Q3 was 12.3%, and we expect Q4 to be approximately 13%.
Just to wrap things up, October consumption continues to be strong.
We're navigating through significant supply challenges and cost inflation.
We expect our portfolio of brands to do well, both in good and bad times and in uncertain economic times such as now.
We have a strong balance sheet, and we continue to hunt for TSR-accretive businesses.
And next up is Rick to give you more details on Q3.
We'll start with EPS.
Third quarter adjusted EPS, which excludes the positive earnout adjustments, was $0.80, up 14.3% to prior year.
We don't expect any further adjustments to the earnout.
The $0.80 was better than our $0.70 outlook, primarily due to continued strong consumer demand and higher-than-expected sales as well as lower incentive comp and lower marketing spend as supply chain shortages were impacting customer fill rates.
We also overcame a higher tax rate year-over-year.
Reported revenue was up 5.7% and organic sales were up 3.7%.
Matt covered the details of the top line.
I'll jump right into gross margin.
Our third quarter gross margin was 44.2%, a 130 basis point decrease from a year ago.
This was below our previous outlook of expansion as we faced incremental pressure from the effect of Hurricane Ida on material costs and distribution.
Gross margin was impacted by 500 basis points of higher manufacturing costs, primarily related to commodities, distribution and labor.
Tariff costs negatively impacted gross margin by an additional 40 basis points.
These costs were partially offset by a positive 250 basis point impact from price/volume mix and a positive 120 basis point impact from productivity.
Marketing was down $10 million year-over-year as we lowered spend to reduce demand until fill rates could recover.
Marketing expense as a percentage of net sales was healthy at 12.3%.
For SG&A, Q3 adjusted SG&A decreased to 180 basis points year-over-year with lower legal costs and lower incentive comp.
Other expense all-in was $12.1 million, a slight decline due to lower interest expense from lower interest rates.
And for income tax, our effective rate for the quarter was 20.4% compared to 17.3% in 2020, an increase of 310 basis points, primarily driven by lower stock option exercises.
We continue to expect the full year rate to be 23%.
And net of cash.
For the first nine months of 2021, cash from operating activities decreased 18% to $653 million due to higher cash earnings being offset by an increase in working capital.
We continue to expect cash from operations to be approximately $950 million for the full year.
As of September 30, cash on hand was $180 million.
Our full year capex plan is now $120 million, down from the original $180 million in the outlook due to project timing.
This capex moves out a year, and we now expect capex in 2022 to exceed $200 million.
Future is bright as we continue to expand manufacturing and distribution capacity, primarily focused on laundry, litter and vitamins.
On October 28, the Board of Directors authorized a new stock repurchase program up to $1 billion.
As you read in the release, this is a sign of our confidence in the company's future performance and the expectations of our robust cash flow generation.
Our number one priority for capital allocation remains acquisitions, and given our low leverage ratios, we have confidence to do both.
Through October, we purchased approximately $130 million worth of shares.
And in Q4, we will likely get ahead of our 2022 planned purchases as well.
And now for the full year outlook.
We now expect the full year 2021 reported sales growth to be approximately 5.5% and organic sales growth to be approximately 4%.
Our consumption is strong and outpacing shipments.
We expect our customer fill levels to improve throughout Q4.
Turning to gross margin, we now expect full year gross margin to be down 170 basis points, previously down to 75 basis points.
This represents an incremental impact from our last guidance due to broad-based inflation on raw costs and transportation costs.
That was exacerbated by Hurricane Ida.
In our prior outlook, we had discussed $125 million of higher cost versus our plan.
That number today is $170 million, and the majority of that increase in the last 90 days relate to transportation, labor, and other increases.
As a reminder, we price to protect gross profit dollars, not necessarily margin.
The $45 million movement versus our previous outlook is primarily noncommodity-related.
Commodity spot pricing today is elevated compared to spot pricing just three months ago.
And now for the full year.
We expect adjusted earnings per share to be 6%.
Our brands continue to go from strength to strength as strong consumption and organic sales growth lap almost 10% organic growth a year ago.
And while inflation is broad based, we have taken pricing actions to mitigate, which gives us confidence over the long term.
For our Q4 outlook, we expect reported sales growth of approximately 3%.
We expect organic sales growth of approximately 2% due to the supply chain constraints and our SPD business to return to a more normal growth rate.
Adjusted earnings per share is expected to be $0.61 per share, up 15% from last year's adjusted EPS.
And with that, Matt and I would be happy to take any questions.
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sees fy sales up about 5.5 percent.
q3 adjusted earnings per share $0.80 excluding items.
sees fy adjusted earnings per share growth at 6%.
expect supply availability issues to begin to abate in first half of 2022 for most of our brands.
expect significant incremental cost increases in 2022.
church & dwight - on october 28, authorized a new stock repurchase program under which up to $1 billion of company's common stock may be repurchased.
church & dwight - now expect fy gross margin to decrease 170 basis points and adjusted operating profit margin expansion of 70 basis points.
church & dwight - faces complexities of raw material, labor shortages at plants, suppliers, third-party manufacturers, exacerbated by hurricane ida.
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Before we begin, let me remind you that the safe harbor provisions of the Private Securities Litigation Reform Act of 1995 apply to this conference call.
In addition, management may also discuss non-GAAP operating performance results during today's call, including earnings, interests, deprecation and amortization, or EBITDA and adjusted EBITDA.
I will begin with highlights for the quarter, and Dave and Nick will follow up with some additional operating detail.
At the outset, I would like to say, although I am very gratified by the company's results in the first quarter, comparisons to the pandemic year of 2020 are analytically difficult.
The pandemic clearly disrupted the hospice industry.
The U.S. government stepped in to help with the relaxation of sequestration and several other operational modifications.
The net effect of the pandemic and the government's actions was to allow VITAS to report an increase in adjusted net income of 25.7% in 2020.
But VITAS had a patient base and its median length of stay fell to 11 days.
The most complex issue still facing VITAS is the disruptive impact that the pandemic has had on traditional hospice referral sources and low occupancy in senior housing.
This disruption continues to impact our admissions and traditional patient census patterns.
Fortunately, admissions in hospitals have largely normalized and some of our senior housing referral sources are beginning to show improvement in occupancy and related referrals.
I firmly believe senior housing will recover.
However, senior housing is in the early stages of recovery and we do not have enough data points to accurately predict when senior housing referrals will return to pre-pandemic levels.
With that said, VITAS is performing in line with our previous guidance.
Roto-Rooter operating results continue to be exceptional.
Strong residential plumbing and drain cleaning demand has been more than adequate to compensate for the slight weakness we continued to observe with our commercial accounts.
We have now had three consecutive quarters of record demand for our Roto-Rooter residential services.
Residential revenue totaled $144 million in the first quarter of 2021, an increase of 32% when compared to the prior year quarter and a 7.2% sequential growth when compared to the fourth quarter of 2020.
Commercial revenue totaled $46.9 million in the quarter, an 8.4% decline when compared with the first quarter of 2020.
Although our Commercial demand has not yet normalized to pre-pandemic levels, this decline has shown significant improvement when compared to the Commercial unit-for-unit revenue declines of 29.1%, 11.6% and 9.8% in the second, third and fourth quarters of 2020, respectively.
Aggregate Roto-Rooter activity, which includes branch operations, independent contractors, as well as franchise fees and product sales, Roto-Rooter generated consolidated first quarter 2020 revenue of $212 million, an increase of 18.9%.
With that, I would like to turn this teleconference over to David.
Let's turn to VITAS segment first.
VITAS' net revenue was $316 million in the first quarter of 2021, which is a decline of 6.5% when compared to the prior year period.
This revenue decline is comprised primarily of a 7.1% decline in days of care.
Our days of care was negatively impacted 111 basis points by the 2020 leap year.
Our first quarter 2021 revenue included a geographically weighted average Medicare reimbursement rate increase, including the suspension of sequestration on May 1, 2020, of approximately 2.8%, offset by acuity mix shift, which reduced revenue by approximately $9.1 million or 2.7% in the quarter when compared to the prior year revenue and level of care mix.
In addition, the combination of a lower Medicare cap and other counter-revenue changes offset a portion of the revenue decline by approximately 50 basis points.
Our average revenue per patient per day in the first quarter of 2021 was $198.95, which, including acuity mix shift, is basically equal to the prior year period.
Reimbursement for routine home care and high acuity care averaged $170.14 and $991.77, respectively.
During the quarter, high acuity days of care were 3.5% of our total days of care, 71 basis points less than the prior year quarter.
In the first quarter of 2021, VITAS accrued $1.5 million in Medicare Cap billing limitations.
This compares to a $2.5 million Medicare Cap billing limitation we recorded in the first quarter of 2020.
Of VITAS' 30 Medicare provider numbers, 27 of these provider numbers currently have a Medicare Cap cushion of 10% or greater.
One provider number has a cap cushion between 5% and 10%.
One provider number has a cap cushion between 0% and 5%.
And one provider number currently has a fiscal 2021 Medicare cap billing limitation liability.
This is based on actual Medicare revenue and admissions in the first six months of the Medicare Cap fiscal year.
VITAS' first quarter 2021 adjusted EBITDA, excluding Medicare Cap, totaled $58.3 million in the quarter, which is a decrease of 3.3%.
Adjusted EBITDA margin in the quarter, excluding Medicare Cap, was 18.4%, which is a 66 basis point improvement when we compare it to the prior year period.
Now let's turn to Roto-Rooter.
Roto-Rooter generated quarterly revenue of $212 million in the first quarter of 2021, an increase of $33.7 million or 18.9% over the prior year quarter.
As Kevin noted earlier, total Roto-Rooter branch commercial revenue totaled $46.9 million in the quarter, a decrease of 8.4% over the prior year.
This aggregate commercial revenue decline consisted of drain cleaning revenue, declining 5.8%, plumbing revenue, declining 5%, and excavation, declining 19.5%.
Water restoration for commercial increased 8.8%.
Our total Roto-Rooter branch residential revenue in the quarter totaled $144 million, an increase of 32% over the prior year period.
This aggregate residential revenue growth consisted of drain cleaning, increasing 29.5%, plumbing expanding 34.9%, excavation increasing 35.8% and water restoration increasing 28.7%.
In the first quarter, our average daily census was 18,050 patients, a decline of 6.1% over the prior year.
As Kevin discussed earlier, this decline in average daily census is a direct result of the disruptions across the entire healthcare system that impacted traditional admission patterns in the hospice starting in March of 2020.
Our hospital generated emissions have largely normalized to pre-pandemic levels.
However, referrals from senior housing, specifically nursing homes and assisted living facilities, continue to be disrupted.
As Kevin mentioned, we have seen stabilization in pockets of improvement in senior housing admissions.
However, it remains too early to reasonably project the pace and time line for senior housing admissions to return to pre-pandemic levels.
In the first quarter of 2021, total admissions were 18,135.
This is a 2.5% decline when compared to the first quarter of 2020.
However, These 18,135 admissions in the first quarter of 2021 compared favorably to the sequential admissions of 16,822, 17,973 and 17,960 in the second, third and fourth quarters of 2020.
In the first quarter, our home-based preadmit admissions decreased 1.5%.
Hospital directed admissions expanded 2.4%.
Nursing home admits declined 26.2%.
And assisted living facility admissions declined 13.1% when compared to the prior year quarter.
Our average length of stay in the quarter was 94.4 days.
This compares to 90.7 days in the first quarter of 2020 and 97.2 days in the fourth quarter of 2020.
Our median length of stay was 12 days in the quarter, which is two days less than the 14-day median in both the first quarter of 2020 and the fourth quarter of 2020.
I will now open this teleconference to questions.
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anticipates providing updated 2021 earnings guidance in july 2021.
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Before we begin, let me remind you that the Safe Harbor Provisions of the Private Securities Litigation Reform Act of 1995 apply to this conference call.
In addition, management may also discuss non-GAAP operating performance results during today's call, including earnings before interest, taxes, depreciation and amortization or EBITDA and adjusted EBITDA.
I will begin with highlights for the quarter, and David and Nick will follow up with additional operating detail.
First, let's start with the obvious.
Operating two separate and distinct service business segments with 17,000 employees during a national pandemic brings unique, unpredictable and abrupt challenges.
Fortunately VITAS and Roto-Rooter have been classified as essential services allowing Chemed to operate during the pandemic.
Maintaining operations in this environment is far from business as usual.
First and foremost, our number one focus has been and will remain on the safety and well-being of our employees, patients and customers.
We will maintain this focus regardless of the cost to safely operate during the pandemic.
April 2020 was probably the most challenging month, we have ever seen significant operating issues emerge daily, triggered primarily from incredibly fast-moving and sometimes contradictory federal, state and local government regulations.
Logistical operating issues were identified, analyzed and solutions for put in practice immediately.
We were able to develop and continuously refine effective work arounds on supply chain issues, labor and scheduling issues, patient access restrictions, employee safety, healthcare protocols, technology solutions as well as information security protocols allowing our employees to continuously serve our local communities in a safe agile manner.
We closely followed the myriad of federal, state and local regulations in the development and implementation of infrastructure necessary to safely allow our field, support and corporate support staff to safely limit as much as practical, physical interaction among our 17,000 employees.
On the VITAS segment, the federal government and specifically HHS and CMS have been exceptionally supportive in terms of relaxing regulations, allowing the use of telehealth capabilities where appropriate and providing pragmatic flexibility in caring for our 19,000 plus patient census.
As most of you are aware on March 27, 2020 the CARES Act was signed in the law.
The CARES Act includes financial support for healthcare providers to maintain operational capacity as well as assist providers with issues caused by the coronavirus panic.
On April 10, 2020, VITAS without application received $80.2 million of CARES Act funds, that was formulaically determined by the federal government based on our 2019 Medicare fee-for-service revenue.
These CARES Act funds are specified to be used to prevent, prepare for and respond to the coronavirus, and shall reimburse the recipient for healthcare-related expenses or loss revenues that are attributable to coronavirus.
The ability of VITAS to retain and utilize the full $80.2 million from the relief fund will depend on the magnitude, timing and nature of the economic impact of COVID-19 within VITAS, as well as the guidelines and rules of the relief fund program.
This financial support is material for VITAS in maintaining its operational capacity at the safely care for our 19,000 patients.
In our first quarter earnings conference call, I stated we anticipated disruption within our patient referral and addition patterns due to significant healthcare system service restrictions in the coming quarter.
This disruption did materialize in our second quarter 2020 admissions declined 3.8% over the prior year.
However, the admissions trend did materially improve throughout the quarter.
Our April 2020 admissions were challenging and had a decline of 6.6%, may improve slightly with admission decline of 5.8%.
June showed significant improvement generated in admissions growth of 1.1%.
Roto-Rooter operations were also severely impacted at the start of the pandemic.
In late March 2020, we observed significant disruption in our Roto-Rooter commercial business.
As a reminder, historically, commercial services represented approximately 28% of Roto-Rooters consolidated revenue.
We made the decision for Roto-Rooter to maintain full staffing and operating capacity with no employee layoffs, as we entered the second quarter.
This decision could maintain our full operating strength was potentially an expenses strategic move and we monitored our demand metrics daily.
The decision to operate at full capacity is a classic risk reward calculation weighing brand awareness, customer satisfaction and the financial needs of our employees.
We also wanted to positioned to capitalize on any potential snapback in commercial and residential demand, both to protect existing marketing share as well as maximize our opportunities to grow market share.
I believe this is proven to be the correct strategic course.
Roto-Rooter services demand began to show weekly improvement beginning in the later part of April, and had strengthened unabated throughout the remainder of the second quarter.
This is reflected in our monthly performance with Roto-Rooter and unit-for-unit commercial revenue declining 38.6% in April, improving slightly to 31.8% decline in May and declining 19.7% in June.
Our residential services have proven to be exceptionally resilient, with our unit-for-unit residential revenue declining a modest 1.6% in April, increasing 11.7% in May and 18.7% in June.
All this translated into Roto-Rooter -- I mean unit-for-unit basis, having the second quarter 2020 commercial revenue declining 29.1%, residential revenue increasing 10.4% and Roto-Rooter consolidated unit-for-unit revenue declining a modest 1.6% when compared to the prior year quarter.
Although, we did have a modest decline in unit-for-unit revenue in the second quarter.
Including acquisitions Roto-Rooter generated consolidate revenue -- consolidated revenue growth of 8.6%.
Overall Roto-Rooter solid revenue growth with excellent adjusted EBITDA margins and adjusted EBITDA growth.
Roto-Rooter's adjusted EBITDA in the second quarter of 2020 totaled $46.8 million, an increase of 20.7%.
The adjusted EBITDA margin was 26.8%, which is a 269 basis point increase when compared to, I'm sorry, excuse me.
The have increase in Roto-Rooter's adjusted EBITDA margin is a contributed to our residential services, having a higher margin than commercial services, as well as increased residential excavation and water restoration services, which have a significantly higher direct contribution margin compared to commercial plumbing and drain cleaning services.
I'm very appreciative of the hard work, creative solutions and willingness of our 7,000 employees to adjust our operational routines and embrace new procedures.
With that, I would like to turn the teleconference over to David.
VITAS' net revenue was $327 million in the second quarter of 2020, which is an increase of 4.7% when compared to our prior year period.
This revenue increase is comprised primarily by 2.8% increase in days of care, a geographically weighted average Medicare reimbursement rate increase, including the suspension of sequestration on May 1 of 2020 of approximately 5.4% and acuity mix shift, which reduced the blended average Medicare rate increase by approximately 310 basis points.
The combination of increased Medicare Cap and a decrease in Medicaid net room and board pass-throughs, as well as reductions in other contra revenue activity, reduced total revenue growth in additional 42 basis points in the quarter.
Our average revenue per patient per day in the second quarter of 2020 was $194.02, which including the impact from acuity mix shift is 2.3% above the prior year period.
Reimbursement for routine home care and high acuity care averaged $165.22 and $985.23, respectively.
During the quarter, high acuity days of care were 3.5% of our total days of care, 69 basis points less than the prior year quarter.
This 69 basis points mix shift and high acuity days of care reduce the increase in average revenue per patient per day from 5.4% to 2.3% in the quarter.
VITAS accrued $5.8 million in Medicare Cap billing limitations and then second quarter of 2020.
This $5.8 million of Medicare Cap, includes approximately $2.3 million of cap liability attributed to the pandemic.
The suspension of sequestration resulted in additional 2% increase in reimbursement effective May 1 of 2020.
In Medicare, provider numbers that we're in a Medicare cap liability situation, there is 2% reimbursement increase was effectively eliminated by a corresponding increase in Medicare cap liability in those markets.
In addition, disruption in Medicare admissions and these Medicare cap liability markets resulted in a further increase in the projected fiscal 2020 Medicare Cap billing limitation.
The second quarter 2020 gross margin excluding Medicare Cap increased cost for personal protection equipment or PPE disinfecting facilities and increased costs for additional paid off or PTO for our front-line employees was 27.2%, which is a 352 basis point margin improvement when compared to the second quarter of 2019.
This increase in gross margin for VITAS is attributed to increased reimbursement from the elimination of sequestration on May 1, 2020.
A level of care mix shift to higher margin routine home care as well as efficiencies from utilizing telehealth were appropriate.
And from cost from reduced admissions volume intake and reduced high acuity hospital referred admissions that have short length of stay and in some cases negative gross margins.
Now let's turn to the Roto-Rooter segment.
Roto-Rooter generated quarterly revenue of $175 million in the second quarter of 2020, an increase of $13.9 million or 8.6% over the prior year quarter.
And a unit-for-unit basis, which excludes the Oakland and Hoffman Southwest acquisitions completed in July 2019 and September 2019 respectively.
Roto-Rooter generated revenue of $158 million for the second quarter of 2020 a modest decline of 1.6% over the prior year quarter.
Total Roto-Rooter commercial revenue, excluding acquisitions, decreased 29.1% in the quarter.
This aggregate commercial revenue decline consisted of drain cleaning revenue decreasing 31.2%, commercial plumbing and excavation declining 28%, and commercial water restoration declining 20.3%.
Total residential revenue, excluding acquisitions increased 10.4%.
This aggregate revenue growth for residential consisted of residential drain cleaning increasing 10.2%, plumbing and excavation expanding 14.4% and commercial water restoration increasing 4.3%.
Roto-Rooter's gross margin in the quarter was 51.2%, a 247 basis point increase when compared to the second quarter of 2019.
Now let's look at consolidated Chemed.
As of June 30, 2020 Chemed had total cash and cash equivalents of $20.4 million and no long-term debt.
On our guidance, historically Chemed earnings guidance has been developed using previous year's key operating metrics, which are then modeled and projected out for the calendar year.
Critical within these projections is the understanding of traditional pattern correlations among key operating metrics.
Once, we complete this phase of our projected operating results, we would then modify the projections for the timing of price increases, changing the commission structure, wages, marketing programs and a variety of continuous improvement initiatives that our business segments plan on executing over the coming year.
This modeling exercise also takes into consideration anticipated industry and macroeconomic issues outside of management's control but are somewhat predictable in terms of their timing and impact on our business segments operating results.
The 2020 pandemic has made accurate modeling and providing meaningful earnings guidance for Chemed exceptionally challenging.
Federal, state and local government authorities are forced to make swift decisions within our healthcare system, labor pools and general economy.
These governmental decisions have the potential for an immediate and material impact on VITAS and Roto-Rooter operating results.
However over the past four months, Chemed has been able to successfully navigate within this rapidly changing environment and produce operating results that we believe provide us with the ability to issue meaningful guidance for the remainder of the calendar year.
However, this guidance should be taken with the recognition the pandemic will continue to materially disrupt all aspects of our healthcare system and general economy to such an extent that future rules, regulations and government mandates could materially impact our ability to achieve this guidance.
With that said, revenue growth for VITAS in 2020, prior to Medicare Cap is estimated to be in the range of 5% to 7%.
Our Average Daily Census in 2020 is estimated to expand approximately 2% to 4%.
And our full-year adjusted EBITDA margin prior to Medicare Cap is estimated to be 19% to 20%.
We are currently estimating $17 million for Medicare Cap billing limitations for the calendar year 2020.
We also anticipate the $80.2 million of CARES Act funds that Chemed just -- Kevin described earlier that our formulaically calculated by the federal government based upon our 2019 Medicare fee-for-service revenue will be adequate to cover our increased costs specifically related to operating our healthcare unit during the pandemic, as well as any incremental Medicare Cap billing limitations that are triggered from declines in Medicare admissions.
I should also note that Chemed's full year adjusted earnings per share guidance eliminate any financial benefit from the CARES Act funds that relate to lost revenue.
We anticipate returning any unused CARES Act to the federal government at the end of the pandemic measurement period.
Roto-Rooter is forecasted to achieve the full year 2020 revenue growth of 9% to 10%.
Adjusted EBITDA for Roto-Rooter for 2020 is estimated to be in the range of 23% to 25%, Based upon this discussion, our full-year 2020 adjusted earnings per diluted share, excluding non-cash expense for stock options, tax benefits from stock options, cost related to litigation, CARES Act funds used for lost revenue and other discrete items is estimated to be in the range of $16.20 to $16.40.
This 2020 full year, calendar year guidance assumes an effective corporate tax rate of 25.2% and as a comparison Chemed's 2019 reported adjusted earnings per diluted share were $13.96.
The interdisciplinary team approach that is the foundation of the hospice benefit has never been more evident for our organization across the country, then through this entire pandemic.
Coordination of our entire team from our sales team providing pandemic relevant education to our disrupted healthcare partner through our admissions teams responding to referrals, enabling our clinical care teams to provide care around the clock with the support of our care coordination centers, home medical equipment division and back office support has been remarkable.
All of this enabled us to care for 19,185 patients each day within the quarter, while bringing on the service 16,822 patients who needed high quality hospice care during this pandemic.
We lived our internal model that we've been sharing during the pandemic, which is, yes, we can, and together we will.
Now let's discuss our second quarter 2020 operating metrics.
As I mentioned in the second quarter, our average daily census was 19,195 patients, an increase of 2.8% over the prior year.
Total admissions in the quarter were 16,822.
This is a 3.8% decline in admissions when compared to the second quarter of 2019.
Admissions performance in the quarter was primarily impacted by the level of disruption, which occurred at each of our referring partners across the healthcare continuum.
For example, admissions from hospitals were pressured due to the reduction in available bed capacity and elective procedures, resulting in fewer patients accessing and subsequently being discharged from hospitals.
Admissions from physician offices, whom were disrupted but were able to remain operational through telehealth interactions saw an increase due to the number of patients choosing to access the disrupted healthcare system through their primary or specialty physician practice along with medical offices.
Lastly, placement of admissions in the nursing homes and assisted-living facilities were significantly impacted due to the barriers and the restriction of access toward new residents.
These types of admission difficulties are reflected in our actual admission results based upon our patient's pre-admit location.
In the second quarter, our admissions increased 7.1% in our home-based preadmit locations.
However, this admission group -- admission growth was more than offset by the combination of hospital admissions declining 4%, nursing home management's decreasing 22.8% and assisted living facility admissions declining 10.2% when compared to the prior year quarter.
Our average length of stay in the quarter was 90.9 days.
This compares to 91.1 days in the second quarter of 2019, in 90.7 days in the first quarter of 2020.
Our median length of stay was 14 days in the quarter, which is two days less than the 16 day median in the second quarter of 2019 and equal to the first quarter of 2020.
Median length of stay is a key indicator of our penetration into the high acuity sector of the market.
First, we will continue to prioritize the safety of our employees, patients and their families as we have successfully done since March.
We have and will continue to source PPE and we are comfortable with the inventory levels to sustain employee need based upon patient and local circumstances.
Additionally, we will continue to utilize the infrastructure we lifted up to manage testing requirements for certain facilities across the country to allow us to safely access our partners' facilities to care for existing patients and placement of new patients when appropriate.
Our entire team will continue to collaborate safely with our local healthcare partners to successfully navigate patients and their families on to the hospice benefit during this unique time.
Lastly, and most importantly, our team will stay committed to persevere and provide care to all the patients and families in need in the communities we serve.
I will now open this teleconference to questions.
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sees fy 2020 adjusted earnings per share $16.20 to $16.40 excluding items.
roto-rooter is forecasted to achieve full-year 2020 revenue growth of 9% to 10%.
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Before we begin, let me remind you that the safe harbor provisions of the Private Securities Litigation Reform Act of 1995 apply to this conference call.
In addition, management may also discuss non-GAAP operating performance results during today's call, including earnings before interest, taxes, depreciation and amortization or EBITDA and adjusted EBITDA.
I will begin with highlights for the quarter, and Dave and Nick will follow up with additional operating detail.
I will then open up the call to questions.
Operating two distinct business units during our global pandemic has been exceptionally challenging.
Fortunately, we have begun to return to normalcy.
The pandemic had created unique problems, logistical hurdles and forced our operations to make significant changes in field and home office procedures.
Many of these changes have been institutionalized and will become part of our normal operating procedures post-pandemic.
I could not be prouder of our management team.
Both VITAS and Roto-Rooter met these pandemic challenges head-on, produced excellent operating results that are well positioned for growth in the coming years.
In April 2020, the first full month of the pandemic, Roto-Rooter experienced an immediate and severe drop in demand for all plumbing and drain cleaning services.
This drop was short-lived.
Starting in May 2020, Roto-Rooter saw a spike in residential plumbing and drain cleaning demand.
This increase in demand was sustained throughout 2020 and has continued unabated in the first six months of 2021.
Commercial demand has also improved up pandemic lows and have now normalized close to pre-pandemic levels.
For the remainder of 2021, I anticipate Roto-Rooter's residential demand to remain at the current run rate, coupled with increased commercial demand as the country returns to normalized pre-pandemic consumer behavior.
The Great Recession, and now a global pandemic.
In each of these crises, Roto-Rooter remained operating and materially increased market share, revenue and operating margin.
Just as important, Roto-Rooter has held on to the increases in revenue market share and margins in past crisis.
Roto-Rooter is well positioned post-pandemic, and we anticipate continued expansion of market share by pressing our core competitive advantages in terms of brand awareness, customer response time and 24/7 call centers and Internet presence.
For VITAS, the most significant issue remaining from the pandemic is the disruption to senior housing occupancy and the related hospital referrals.
Recent admissions' data suggest senior housing has entered into the early stages of recovery, and our updated guidance anticipates steady improvement in the senior housing referred hospice admissions in the second half of 2021, with a further acceleration in senior housing admissions anticipated in the fourth quarter.
With that, I would like to turn this teleconference over to David.
Let's turn to VITAS.
VITAS' net revenue was $312 million in the second quarter of 2021, which is a decline of 4.7% when compared to the prior year period.
This revenue decline is comprised primarily of a 6.3% reduction in our days of care, offset by a geographically weighted Medicare reimbursement rate increase of approximately 1.8%.
Acuity mix shift did have a net impact of reducing revenues approximately $3.8 million in the quarter or 1.2%.
The combination of a lower Medicare Cap billing limitation and other contra-revenue charges offset a portion of the revenue decline by roughly 90 basis points.
VITAS did accrue $2 million in Medicare Cap billing limitations in the second quarter of 2021, and this compares to a $5.7 million Medicare Cap billing limitation in the second quarter of 2020.
Of our 30 Medicare provider numbers, right now 27 of these provider numbers have a Medicare Cap cushion of 10% or greater.
One of our provider numbers has a cap cushion between 0% and 5%, and two of our provider numbers currently have a fiscal 2021 Medicare Cap billing limitation liability.
Let's take a look at Roto-Rooter.
Roto-Rooter generated revenue of $220 million in the second quarter of 2021, which is an increase of $45.6 million or 26.1% over the prior year quarter.
Total Roto-Rooter branch commercial revenue totaled $50.3 million in the quarter, an increase of 31.8% over the prior year.
The aggregate commercial revenue growth consisted of our drain cleaning revenue increasing 39.8%, plumbing increased 32.4% and excavation expanding 25.8%.
Water restoration also increased 8.3% on the commercial side.
On the residential side, total residential revenue in the quarter totaled $149 million, an increase of 23.7% over the prior year period.
The aggregate residential growth consisted of drain cleaning increasing 20.6%, plumbing expanding 30.7% and excavation increasing 22.4%.
Water restoration also increased 23.1%.
Basically increases across the board, all segments, both commercially and residential.
Now let's look at Chemed on a consolidated basis.
During the quarter, Chemed repurchased 250,000 shares of stock for roughly $122 million, which equates to a cost per share of $487.53.
As of June 30, 2021, there was approximately $312 million of remaining share repurchase authorization under this plan.
We've also updated our 2021 earnings guidance as follows: VITAS' full year 2021 revenue prior to Medicare Cap is estimated to decline approximately 4.5% when compared to 2020.
Our average daily census in 2021 is estimated to decline approximately 5%.
This guidance anticipates senior housing occupancy will begin to normalize to pre-pandemic occupancy, starting in the second half of calendar year 2021.
VITAS' full year adjusted EBITDA margin prior to Medicare Cap is forecasted to be 18.3%, and we are currently estimating $7.5 million for Medicare Cap billing limitations in calendar year 2021.
That's an improvement from the initial $10 million of Medicare Cap we estimated at the start of this year.
Roto-Rooter is forecast to achieve full year 2021 revenue growth of 15% to 15.5%.
Roto-Rooter's adjusted EBITDA margin for 2021 is estimated to be between 28% and 29%.
So based upon this discussion, our full year 2021 adjusted earnings per diluted share, excluding noncash expense or stock options, any tax benefits we receive from stock option exercises as well as costs related to litigation and other discrete items, is estimated to be in the range of $18.20 to $18.50.
The revised guidance compares to our initial 2021 guidance of adjusted earnings per diluted share of $17 to $17.50.
In the second quarter, our average daily census was 17,995 patients, a decline of 6.3% over the prior year.
This decline in average daily census is a direct result of pandemic-related disruptions across the entire healthcare system.
This negatively impacted traditional hospice admission patterns, starting in March of 2020.
Our hospital generated admissions have largely normalized to pre-pandemic levels.
Referrals from senior housing, specifically nursing home and assisted living facilities continue to be disrupted.
During the second quarter, we have seen admission stabilization and pockets of improvements in senior housing admissions.
However, it remains too early to accurately project the pace and timeline for senior housing admissions to fully return to pre-pandemic levels.
In the second quarter of 2021, total VITAS admissions were 16,840.
This is a slight improvement when compared to the second quarter of 2020 admissions.
More importantly, admissions in the second quarter of 2021 exceeded discharges by 315 patients.
This is the first quarter since the pandemic began that our patient admissions have exceeded patient discharges.
This is the strongest indication to date that we are now beginning the process of rebuilding census to pre-pandemic levels.
In the second quarter, our hospital directed admissions expanded 7.8% and emergency room admits decreased 9%.
Total home-based preadmit admissions decreased 9.3%, nursing home admits declined 9.9%, assisted living facility admissions declined 17.5% when compared to the prior year quarter.
Our average length of stay in the quarter was 94.5 days.
This compares to 90.9 days in the second quarter of 2020 and 94.4 days in the first quarter on 2021.
Our median length of stay was 14 days in the quarter, which is equal to the second quarter of 2020 and is a 2-day improvement when compared sequentially to the first quarter of 2021.
It's now time for us to consider any questions that come before the teleconference.
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sees fy adjusted earnings per share $18.20 to $18.50 excluding items.
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Before we begin, let me remind you that the safe harbor provisions of the Private Securities Litigation Reform Act of 1995 apply to this conference call.
In addition, management may also discuss non-GAAP operating performance results during today's call, including earnings before interest, taxes, depreciation and amortization or EBITDA and adjusted EBITDA.
Kevin McNamara, President and Chief Executive Officer of Chemed Corporation; Dave Williams, Executive Vice President and Chief Financial Officer of Chemed; and Nick Westfall President and Chief Executive Officer of Chemed's VITAS Healthcare Corporation subsidiary.
Sherri is retiring at the end of the year, and this is her last introduction to our quarterly conference call.
I will begin with highlights for the quarter.
And David and Nick will follow up with additional operating detail.
Our third quarter 2021 operating results released last night, reflect very solid performance for both VITAS and Roto-Rooter.
On a go-forward basis, I would like to share with you some of the macro issues we are dealing with as we approach the end of the second year of the pandemic.
For VITAS, the most important issue, we are managing labor.
Staffing of license professionals has been exceptionally challenging to ensure adequate mix of license healthcare workers on a market by market basis.
This is particularly challenging during the pandemic, as we deal with dynamic fluctuations in patient census in every market.
Turnover within our license staff remains above our pre-pandemic rates, but we are seeing indications of normalization, as we continue to expand our hiring and retention initiatives in many markets.
Beyond managing our staffing levels, we are observing increasing pressure on salaries and wages.
To date, we've managed these pressures with increased paid time off or PTO, we view it as inevitable that healthcare wages will increase if we continue to have a nationwide systemic imbalance in supply and demand for license healthcare professionals.
Fortunately, for VITAS and the hospice industry, there is a natural hedge against the inflationary pressures on costs, specifically labor.
The annual increase in the Medicare and Medicaid hospice reimbursement rates is based primarily on inflation in the hospital wage index basket, as measured by the federal government's Bureau of Labor Statistics.
Typically, the annual inflation measured as of March 31 is used to determine the following October 1 reimbursement increase.
This should give the hospice industry reasonable stability in operating margins in an inflationary environment, albeit with a six month lag from the inflation measurement to the actual reimbursement increase.
The second critical challenge for VITAS is the continued disruption to senior housing occupancy and the latest hospice referrals.
A recent admission data suggests senior housing is in the process of recovery pre-pandemic nursing home base patients represented 18% of our total average daily census or ADC.
The nursing of ADC ratio hit a low of 14.3% in the first quarter of 2021.
In the second quarter of 2021 nursing home base patients increased 60 basis points to 14.9%.
And then, the third quarter of 2021, our nursing home patients represented 15.6% of our total ABC.
Our updated 2021 guidance anticipates sequential improvement in senior housing base patients in the fourth quarter of 2021 with acceleration in senior housing admissions anticipated in 2022.
For Roto Rooter, our must significant challenge has been to increase manpower.
We've expanded technician manpower by 8% in 2021.
However, based on our current demand levels, we continue to remain understaffed in many of our markets.
Technician compensation plays a role in recruiting new employees as well as retention of our existing employee base.
Our average 2021 technician and field sales force compensation is over $81,000 per year.
Most of our technicians are paid out on a commission basis of revenue generated.
As a result, pricing for our services is a critical component in increasing technician wages.
We're anticipating passing to inflationary price increases in all our markets in the fourth quarter of this year.
Demand for plumbing, drain cleaning, excavation, and water restoration services remain at record levels.
I want to give additional color on the depth and breadth of this increase in demand.
Let's compare Q3 2021 revenue to Q3 2019.
Excluding the HSW acquisition, which was completed in September 2019, under this unit for unit comparison, residential services have experienced incredible growth.
In aggregate, residential branch revenue increased 46.2% over this two-year period.
On a service segment basis, residential plumbing revenue increased 37.1%; drain cleaning expanded 36%; excavation increased 65.6%; and water restoration increased 48.1%.
Commercial demand has been more challenging, however, commercial revenue has experienced a significant recovery since the 40% decline in commercial demand noted in April 2020.
Overall, commercial revenue declined 3.1% over this 2-year period.
On an individual service segment basis, commercial plumbing service declined 4.9%, drain cleaning expanded 1.8% excavation declined 10.2%, and water restoration increased 7%.
We anticipate continued strengthening in commercial demand in the fourth quarter of 2021, as well as throughout 2022.
Over the past 20 years, the country has faced 9/11, the Great Recession, and now a global pandemic.
In each of these crises, Roto-Rooter remained operating and materially increased market share revenue and operating margin.
Just as important, post-crisis, Roto-Rooter held on to these increases in revenue market share and margins.
Roto-Rooter is well positioned postpaid pandemic, and we anticipate continued expansion of market share, by pressing our core competitive advantages in terms of brand awareness, customer response time, 24-7 call centers and Internet presence.
With that, I would like to turn the teleconference over to David.
VITAS's net revenue was $317 million in the third quarter of 2021, which is a decline of 5.8% when compared to the prior year period.
This revenue decline is comprised primarily of a 5.3% decline in days of care, partially offset by a geographically weighted average Medicare reimbursement rate increase, including the suspension of sequestration of approximately 1.2%.
Our acuity mix shift had a net impact of reducing revenue approximately $3 million or nine-tenths of 1% in the quarter, when compared to the prior-year revenue and level of care mix.
The combination of Medicare Cap and other contra-revenue changes, negatively impacted revenue growth, an additional 80 basis points.
VITAS accrued $100,000 in Medicare Cap billing limitations in the quarter.
This compares to $4.1 million reversal of Medicare Cap billing limitations in the third quarter of 2020.
Of our 30 Medicare provider numbers, 27 of these provider numbers currently have a Medicare Cap cushion of 10% or greater.
One provider number has a cap cushion between 0% and 5%.
And two of our provider numbers have a fiscal 2021 Medicare Cap billing limitation liability.
Roto-Rooter, generated quarterly revenue of $221 million in the third quarter of 2021, which is an increase of $30.1 million or 15.7% when compared to the prior year quarter.
Roto-Rooter's branch residential revenue in the quarter totaled $151 million, which is an increase of $22.2 million or 17.2% over our prior year period.
This aggregate residential revenue growth consisted of drain cleaning, increasing 11.7%, plumbing expanding 17.4%, excavation increasing 14.1%, and water restoration increasing 28%.
Roto-Rooter branch commercial revenue in the quarter totaled $52.3 million, which is an increase of $4.7 million or 10% over the prior year.
The aggregate commercial revenue growth consisted of drain cleaning increasing 17.6%, plumbing increasing 9.3%, and commercial excavation declining 1.3%.
Water restoration also increased 9.4%.
Now, let's turn to Chemed on a consolidated basis.
During the quarter, we repurchased 350,000 shares of Chemed stock for $164 million, which equates to a cost per share of $467.80.
As of September 30 of 2021, there is approximately $148 million of remaining share repurchase authorization under this plan.
Chemed restarted its share repurchase program in 2007.
Since that time, Chemed has repurchased approximately 15.2 million shares, aggregating approximately $1.7 billion, at an average share cost of $113.04.
Including dividends over the same period, Chemed has returned approximately $1.9 billion to shareholders.
We have updated our full-year 2021 guidance as follows: VITAS was 2021 revenue, prior to Medicare Cap, is estimated to decline approximately 5% when compared to the prior year period.
Average daily census in 2021, is estimated to decline 5.5%.
In our full-year adjusted EBITDA margin, prior to Medicare Cap, is estimated to be 18.8%.
We're currently estimating $6.6 million for Medicare Cap billing limitations release calendar year 2021.
Roto-Rooter is forecasted to achieve full-year 2021 revenue growth of 17.3%.
Roto-Rooter's adjusted EBITDA margin for 2021 is estimated to be between 28.5% and 29%.
Based on the above full-year 2021 adjusted earnings per diluted share, excluding non-cash expense for stock options, tax benefits from stock option exercises, cost related to litigation and other discrete items, is estimated to be in the range of $19 to $19.20.
This compares to our initial 2021 adjusted earnings guidance per diluted share of $17 in $17.50.
This revised 2021 guidance assumes an effective corporate tax rate on adjusted earnings of 25.1%.
This compares to Chemed's 2020 reported adjusted earnings per diluted share of $18.8.
In the third quarter, our average daily census was 18,034 patients, a decline of 5% over the prior year and 0.2% increase when compared to the second quarter of 2021.
This year-over-year decline in average daily census is a direct result of pandemic related disruptions across the entire healthcare system since March of 2020.
Our hospital generated emissions have largely normalized to pre-pandemic levels.
Referrals from senior housing, specifically nursing homes and assisted-living facilities, continue to be disrupted.
During the third quarter, we've seen admission stabilization and pockets of improvement in senior housing admissions.
However, it remains too early to accurately project the pace and time line for senior housing admissions to fully return to pre-pandemic levels.
In the third quarter of 2021, total VITAS admissions were 17, 598.
This is a 1.9% decline when compared to the third quarter of 2020 admissions and a 4.5% sequential increase when compared to the second quarter of 2021.
In the third quarter, on a year-over-year basis, our hospital directed admissions declined 0.8%.
Total home-based pre-admit admissions decreased 8.3%, nursing home admits declined 0.2%, and assisted living facility admissions declined 8.6%.
When you compare our third quarter 2021 admissions to the second quarter of 2021, we generated solid sequential improvement with hospital directed admissions improving 2%, total home based pre-admit admissions increasing 16.3%, nursing home admits expanding 8.9%, and assisted living facility admissions increasing 5% sequentially.
Our average length of stay in the quarter was 96 days.
This compares to 97.1 days in the third quarter of 2020 and 94.5 days in the second quarter of 2021.
Our median length of stay was 13 days in the quarter and compares to 14 days in the third quarter of 2020, and is equal to the second quarter of 2021.
I will now open this teleconference to questions.
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sees fy adjusted earnings per share $19.00 to $19.20 excluding items.
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They will be joined by Scott Oaksmith, Senior Vice President, Real Estate & Finance.
As you'll hear today, we believe that the deliberate set of strategic decisions we've made in recent years and our targeted actions during the pandemic, along with the dedication and hard work of our franchise owners to navigate the impact of the pandemic, drove impressive results that position us well to further capitalize on growth opportunities in 2021 and beyond.
Throughout my remarks today, I'll provide comparisons not only to prior year, but also to 2019, which we believe are more meaningful in analyzing performance trends as the prior year's quarter results were impacted by the pandemic.
In the first quarter of 2021, we once again delivered results that significantly outperformed the industry, our chain scale segments and local competition, and we expanded our adjusted EBITDA margins to 69%.
Our domestic systemwide year-over-year RevPAR change surpassed the industry by 23 percentage points, declining 4.4% and 18.7% as compared to the same quarters of both 2020 and 2019 respectively.
And we continued to achieve sequential quarter-over-quarter improvement.
In addition, we generated steady month-over-month growth in our choicehotels.com and other proprietary digital channels revenue contribution mix throughout the quarter.
We also benefited from our most loyal customers, Choice Privileges Diamond Elite members, who contributed an even higher percentage of overall revenue for the quarter as compared to 2020 and 2019.
These results have helped us increase RevPAR index versus our local competitors by over 6 percentage points in the first quarter as compared to 2019.
We achieved that through notable lifts in both weekday and weekend RevPAR index and up significantly across all location types as reported by STR.
For over a year, we've observed significant RevPAR share gains against the competition as compared to 2019 giving us further optimism about our future revenue trajectory.
However, our April RevPAR results are truly remarkable, marking near returns to 2019 levels.
Aided by our strong value proposition and continued outperformance, demand for new franchise contracts grew significantly in the first quarter.
Likewise, our franchise owners are remaining with Choice as seen in our industry-leading voluntary franchisee retention rate and owners who choose to build and develop hotels in the current environment increasingly seek our brands.
For the first quarter we awarded nearly 90 new domestic franchise agreements and over 50% increase over the same period of 2020.
Of the total new domestic agreements, over 80% were for conversion hotels.
These hotels historically open about three to five months after contract execution.
Throughout the first quarter, we also continued to grow our effective royalty rate, a reflection of the continued strengthening of the value proposition we provide to our franchise owners.
These results and our optimism for the future led us to reinstate the dividend at the pre-pandemic level and resume our share repurchase program.
Underpinning our first quarter success are the deliberate decisions and strategic investments that we've made in our product portfolio, our value proposition, our platform capabilities and other franchisee facing tools.
These investments allowed us to not only capitalize on demand that historically has driven our core business, but also enabled us to attract new travel demand to new market locations and our key segments such as extended stay and upscale.
In fact, we believe we are now better positioned to increase our share of travel demand in the years to come than we were prior to the onset of the pandemic.
We pride ourselves on investing in our high-quality well segmented portfolio of brands and this sets us apart with our franchise owners.
We constantly monitor changing consumer preferences and strategically manage our portfolio to ensure we are building the brands of tomorrow in key strategic segments that provide a compelling return on investment.
Last year we launched our newest mid-scale extended stay brand Everhome Suites to provide franchisees with another opportunity to capitalize on this fast-growing segment in the hotel industry and help drive returns in practically any economic environment.
As hotel financing starts to rebound, we anticipate developers increased demand for this new product.
In fact, in April, we met with over 25 developers and toward the new model room for this exciting brand and interest is very high.
We also proactively reinvested into the future of our product portfolio with Comfort's Move to Modern refresh program, which has been recently completed and the launch of the new Comfort prototype this quarter to help the brand family maintain its leadership position in the upper mid-scale segment for years to come.
And we remain focused on growing our strategic conversion brands specifically, Clarion Pointe, a relatively new brand extension to the Clarion brand has experienced a five-fold increase of its portfolio and the Ascend Hotel Collection has increased the number of its domestic rooms by over 25% since the end of 2019.
Based on our strong track record of organic growth, we believe these internal investments will continue to drive attractive returns for years to come.
At the same time, we continue to invest in our value proposition capabilities.
We enhanced our pricing and merchandizing tools to further enable our franchise owners to reach their target customers and effectively drive top line revenue to their hotels while reducing their total cost of ownership.
These tools are contributing to the outperformance our brands are experiencing.
We also provided our guests with additional travel options by signing strategic agreements with new travel partners such as Penn National Gaming.
Finally, the decisions we've made to better align our cost structure in the post-pandemic environment that are here to stay, position us well to capitalize on opportunities as travel demand recovers, while allowing us to continue to invest for the long-term.
We have maintained competitive share gains since the onset of the pandemic and we expect our momentum to continue, while uncertainty remains we are observing positive signs of recovery that give us confidence for 2021 and beyond.
With the vaccine rollout pace accelerating and consumer confidence at its highest level since the pandemic began, Americans are feeling more optimistic about the prospect of traveling again.
Indeed recent studies point to a significant uptick in consumers intent to travel in the next six months.
We've observed that throughout the first quarter and particularly in the month of April, our customers are planning their travel further in advance as witnessed by the lengthening of average booking windows.
We are also pleased to see that our first quarter experienced over 400 basis points weekday occupancy index share gains as compared to 2019.
As discussed on our prior calls, we believe the share gains are partially driven by long-term consumer trends, such as remote work, virtual learning and early retirements which afford more Americans flexibility in where and when they travel for leisure.
Additionally, we are seeing sequential quarter-over-quarter improvements in our business travel booking trends.
As a matter of fact, even our group travel is showing signs of recovery with the sports segment bookings expectations for this year already exceeding 2019 levels.
We continue to observe positive trends and rising outlooks across most key domestic economic indicators.
Additionally stimulus checks from the recent financial relief package, high household savings and business reopenings all point to a continued recovery for our small business franchise owners and middle class consumers, our core customers.
I'll now provide a brief update on our key segments where are all of our brands achieved RevPAR index gains as compared to 2019 versus their local competitors through the first quarter.
Our Extended Stay segment is a significant growth engine for the company.
The acquisition of the WoodSpring Suites brand in 2018 and our strategic investments in the Extended Stay segment, allowed us to nearly quadruple the size of the portfolio over the past five years, with the segment now representing 10% of our total domestic rooms.
In the first quarter the Extended Stay segment rapidly expanded by 44 units year-over-year from the first quarter of 2020 and now stands at nearly 455 domestic hotels with a domestic pipeline of 310 hotels.
We expect this Extended Stay unit growth rate to further accelerate in the future.
Once again, our purpose-built brand tailored for long-term guests outperformed the competition in this cycle resilient segment.
The WoodSpring Suites brand is our first brand to experience RevPAR levels that exceeded our 2019 results.
For the first quarter as compared to 2019, WoodSpring reported over 3% RevPAR growth, driven by a more than 4% increase in average daily rate and an average occupancy rate of 74%, a truly remarkable achievement.
The brand's pipeline continues to expand year-over-year and reached nearly 150 domestic hotels at the end of March 2021.
Our Suburban Extended Stay brand experienced 10% year-over-year domestic unit and pipeline growth.
At the same time our MainStay Suites mid-scale extended stay brand captured over 13 percentage points in RevPAR index gains versus its local competitors as compared to 2019.
The brand's portfolio expanded to over 90 domestic hotels open a 26% increase year-over-year.
The increased developer interest we are seeing reaffirms that our strategic commitment and continued investments in this highly cycle-resistant segment are driving a competitive advantage.
Given these results, we remain optimistic about the growth potential of our Extended Stay portfolio.
Our mid-scale brands represent over two-thirds of our total domestic portfolio and over half of the total domestic pipeline.
As we celebrate Comfort's 40th anniversary this year, the brand's continued growth and performance success is proved positive that we invest for the long-term.
Our efforts to transform the brand are paying off, specifically the Comfort Family achieved RevPAR index gains versus its local competitors of nearly 10 percentage points and a RevPAR change that was nearly 11 percentage points more favorable than the upper mid-scale chain scale in the first quarter as compared to 2019.
In March, we officially launched the much anticipated rise and shine prototype which maintains Comfort's low cost to build advantage over its competition and is designed to meet guest expectations for an elevated experience.
The Comfort brand family reached over 260 hotels in its domestic pipeline, over one quarter of which are hotels awaiting conversions, which we believe will fuel the brand's growth in the near term.
And finally, Clarion Pointe, ended the first quarter by achieving a milestone of the 30th hotel opened in the United States and more than 20 additional hotels awaiting conversion in the near term.
Our upscale portfolio achieved impressive year-over-year growth in the first quarter, where we increased our domestic upscale room count by 22% and marked the highest number of openings in a given quarter, matching the company's all-time record.
In addition, developer interest in our upscale brands remained high as we more than quadrupled the number of domestic franchise contracts in the first quarter year-over-year.
The Ascend Hotel Collection leads the industry as the first and largest soft brand.
The brand grew its domestic room count by nearly 26% year-over-year and expanded to nearly 380 hotels open around the globe.
Ascend Hotels achieved the following performance in the first quarter as compared to the same period of 2019.
The brand outperformed the upscale segment RevPAR change by 19 percentage points.
It achieved RevPAR index gains of 12 percentage points against its local competitors and it recorded average daily rate index gains of 11 percentage points.
This performance further enhance the brand's attractiveness to developers looking for a smart conversion opportunity which was showcased in the brand's strong franchise agreements activities for the quarter.
Our upscale Cambria Hotels brand continues its positive momentum, growing its portfolio size by 14% to 57 units with 18 projects under active construction at the end of March.
The brand continues to build on its success with four hotels already opened year-to-date and five additional planned to open through the end of the summer.
Consumer confidence in Cambria Hotels drove the brand RevPAR share gains versus its local competitors to 16 percentage points in the first quarter as compared to 2019.
These results are proof of Choice Hotels value proposition in the upscale segment for our current and prospective owners.
We're also committed to enhancing our value proposition by growing our platform business.
In the first quarter, we further expanded our attractive upscale platform and successfully on-boarded 22 Penn National Gaming Casino resort properties, representing nearly 7,000 rooms joining our Ascend Hotel Collection.
This strategic agreement will offer our more than 48 million Choice Privileges members the opportunity to earn and redeem points at these Penn properties by booking their stays directly on choicehotels.com.
We are proud of everything we've accomplished this quarter, but we certainly could not have done it without the dedication of our associates and the strength of our award-winning culture, focused on diversity, equity and belonging.
I'm especially pleased to say that Choice was recently named by Forbes as one of the best employers for diversity and one of America's best mid-size employers, as well as one of the best places to work by comparably.
Our strategic approach, resilient business model, high quality well segmented portfolio brands and strong balance sheet will help us to further capitalize on growth opportunities in 2021 and beyond.
With that, I'll hand it over to our CFO, Dom?
I hope you and your families are all well.
Today, I'd like to provide additional insights around our first quarter results, update you on our liquidity profile and approach to capital allocation and finally share our thoughts on the outlook for the road ahead.
Taking a closer look at our results for the first quarter 2021, total revenues excluding marketing and reservation system fees were $91.4 million.
Adjusted EBITDA totaled $63.1 million driven by improving RevPAR performance and our ability to realize adjusted SG&A savings of 20% and our adjusted EBITDA margin expanded to 69%, a 330 basis point increase year-over-year.
As a result, our adjusted earnings per share were $0.57 for the first quarter.
Let's take a closer look at our three key revenue levers, beginning with RevPAR.
Our domestic systemwide RevPAR outperformed the overall industry by 23 percentage points for the first quarter, declining 18.7% from 2019, compared to 2020, our first quarter 2021 RevPAR declined only 4.4%.
At the same time, our first quarter results exceeded the primary chain scale segments in which we compete as reported by STR, by over 8 percentage points versus 2019.
Our domestic systemwide occupancy rate has seen significant improvement since mid-March 2021.
In fact, starting in mid-March, we've experienced our highest occupancy levels since the start of the pandemic, with systemwide occupancy rates exceeding 70% on numerous days.
We are optimistic that these demand trends will remain elevated, especially throughout summer and will further strengthen the financial health of our franchisees.
The trends of improving RevPAR performance have continued into the second quarter.
Our April performance was significantly stronger with a RevPAR decline of approximately 4% and an occupancy rate increase of 80 basis points versus 2019 levels.
These trends give us even greater optimism for our 2021 performance.
We've long focused our brand strategy on driving growth across the higher value and more revenue intense upscale, extended stay and mid-scale segments and the investments we've made are paying off.
In the first quarter, these strategic segments helped us achieve material RevPAR change outperformance against our respective industry chain scales and drove gains versus our local competitors.
Specifically when compared to first quarter 2019, our upscale portfolio increased its RevPAR index relative to its local competitive set by 14 percentage points.
Our extended stay portfolio outperformed the industry's RevPAR change by an impressive 38 percentage points and grew versus its local competitive set by 10 percentage points.
And finally the RevPAR change for our mid-scale and upper mid-scale portfolio exceeded these segments by 9 percentage points.
For the first quarter 2021 versus the same period of 2019, all of our brands achieved RevPAR index gains versus their local competitors.
In fact, we were able to increase our overall RevPAR index against local competitors by over 6 percentage points, notably through our franchisees' ability to maintain rate integrity.
More specifically, our average daily rate improved from the prior quarter and our average daily rate index increased 3.7 percentage points as compared to 2019.
We've also observed firsthand that our investments in pricing optimization capabilities for our franchisees are paying off.
At the same time, we continue to grow the overall size of our franchise system and open the highest number of hotels in any first quarter in the past 10 years.
Across our more revenue intense brands in the upscale extended stay and mid-scale segments we observed stronger unit growth, increasing the number of hotels by 2.4% year-over-year and improving the growth from fourth quarter 2020.
For full year 2021, we expect our overall unit growth trend to continue.
Furthermore, we expect the unit growth of the more revenue intense segments to accelerate versus 2021 and range between 2% and 3%.
Aided by our strong value proposition and outperformance, demand for our brands continue to gain momentum since the beginning of the year with over half of the domestic agreements executed in the month of March.
Specifically, we saw an increase in demand for our conversion brands with domestic conversion contracts up 76% year-over-year.
Our royalty rate remains a significant source of our revenue growth, which is driven by the attractive value proposition we provide to our franchisees, their continued desire to be affiliated with our proven brands and our pipeline.
The company's domestic effective royalty rate exceeded 5% for the first time ever in a quarter and increased 7 basis points year-over-year for the first quarter compared to the prior year.
We expect to maintain the historical growth trajectory of this lever in 2021 as owners seek Choice Hotels proven capabilities of delivering strong top line revenues to their hotels, while helping them maximize return on investment.
I'd now like to turn to our liquidity profile and share capital allocation update.
Our strong results have led to an even stronger liquidity position for the company.
At the end of first quarter 2021, the company had approximately $823 million in cash and available borrowing capacity through its revolving credit facility, even though our cash generation tends to be weaker in the first quarter, due to the seasonality of our business and other cash outlays.
Given the continuing improvements in our operations, our strong liquidity and credit profile and our increasing optimism for 2021 and beyond, our Board has approved the reinstatement of our quarterly dividend at the pre-pandemic level beginning in July 2021.
Additionally, the Board has also approved the resumption of the company's share repurchase program.
Both actions highlight the confidence we have in our business to continue generating strong levels of cash and are a testament to our impressive results, while reflecting our continued commitment to driving long-term shareholder value and returning excess capital to our shareholders.
Nevertheless, our capital allocation philosophy remains unchanged.
We will continue to be disciplined stewards of capital and take steps that we believe will maximize shareholder value.
Choice's primary objective in this area has always been to increase organic growth by strategically investing back into the business.
We will continue to monitor the environment for other investment opportunities and evaluate capital returns in the context of our leverage levels, market conditions and our overall capital allocation strategy.
I'd like to offer some thoughts on what lies ahead.
While we are not providing formal guidance today, we currently expect RevPAR change for the remainder of the year to be stronger than first quarter 2021 results versus both 2020 and 2019.
Our view is reinforced by the following: First, we continue to see consumers' desire to travel climbing aided by the vaccine rollout and improving domestic economic environment and higher levels of consumer savings.
Second, we are pleased that our domestic RevPAR change has continued the pattern of sequential improvement with significantly stronger April RevPAR results versus 2019 and trends continuing into May.
We currently expect strong travel demand trends to continue.
Finally, we continue to be optimistic given other positive trends such as demand increases in key urban locations and our share gains in business travel, combined with the continued resilience of leisure demand.
We will continue to evaluate the impact of COVID-19 across the business and we'll provide further updates in August during our next earnings call.
In closing, we remain optimistic that Choice Hotels is well positioned to succeed in 2021 and beyond.
Our resilient, primarily asset light franchise-focused business model which has historically delivered stable returns throughout economic cycles and provided a degree of cushion from market risks will continue to benefit us in the long run.
Our investments for the long-term that propel our future forward coupled with our strategic approach, disciplined capital allocation strategy and strong balance sheet will allow us to continue to capitalize on opportunities during the recovery and drive outsized returns for years to come.
At this time, Pat and I would be happy to answer any questions.
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compname posts q1 adjusted earnings per share $0.57.
q1 adjusted earnings per share $0.57.
not providing formal guidance for q2 or full year 2021.
choice hotels international - currently expects revpar change for remainder of 2021, as compared to both 2019 and 2020, to outperform q1 2021 results.
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Actual results may differ materially from those indicated in forward looking statements, and you should consult the company's Forms 10-Q, 10-K and other SEC filings for information about important risk factors affecting the company, that you should consider.
These forward looking statements speak as of today's date, and we undertake no obligation to publicly update them to reflect subsequent events or circumstances.
He'll be joined by Scott Oaksmith, Senior Vice President, Real Estate and Finance.
We appreciate you taking your time to join us.
I'm pleased to report that Choice Hotels has continued to deliver strong results that once again significantly outperformed the industry and gained share across all segments in which we compete.
Our June and July RevPAR results exceeded 2019 levels by approximately 5% and 15%, respectively.
A truly remarkable achievement.
For almost 1.5 years, we've maintained significant RevPAR index share gains against the competition as compared to 2019.
In fact, this quarter, we increased RevPAR index versus our local competitors by nearly five percentage points as compared to 2019, through notable lift in both weekday and weekend RevPAR index as reported by STR.
Retaining these elevated competitive share gains even as the broader industry recovers illustrates that our strategic investments are working and gives us further optimism about our future revenue trajectory.
Our goal is not simply to return to our 2019 performance levels but rather to capitalize on current and future investments to fuel our long term growth and drive our performance to new levels.
As previously discussed, we were very intentional in our approach to investing prior to the pandemic to drive growth across the more revenue intense hotel segments.
While we reduced our overall spend in 2020 due to the pandemic, we continue to invest in key strategic areas.
More importantly, in today's stronger demand environment, we see an outsized opportunity to continue or even accelerate strategic investments to capture a greater share of travel demand.
What gives us optimism is that the bold investments we've continued to make are paying off.
These include launching and enhancing brands in each of our strategic segments, namely expanding our upscale positioning, strengthening our mid scale leadership role and rapidly growing our extended stay portfolio.
We're also improving our guest delivery at the hotel level, while strengthening our marketing and reservation systems and franchisee tools that have contributed to the outperformance our brands are demonstrating.
We are also bolstering our platform capabilities through the strategic partnerships that drive incremental revenue to our existing portfolio, allowing us to play in nontraditional segments, such as gaming and all inclusive resorts among others.
I will now outline more specifically why we are confident that we can continue to increase our share of travel demand in the years to come.
First, we strengthened our existing brands and launched new brands to appeal to the customer of tomorrow in key segments that provide a compelling return on investment.
Our strategic investments in the extended stay segment allowed us to quadruple the size of the portfolio over the past five years to reach 460 domestic units with a domestic pipeline of over 300 hotels.
Last year, we launched our newest mid scale extended stay brand, Everhome Suites, to provide franchisees an opportunity to capitalize on the best performing segment of the hotel industry.
The interest level from multi-unit developers backed by institutional capital for this new product is high, similar to what we are seeing with our WoodSpring Suites brand.
In our mid scale segment, we have reinvested in the future of our brand portfolio with Comfort moved to modern transformation.
The Comfort portfolio grew its domestic unit count by 2.5% in the second quarter year over year and recently celebrated the highest number of openings since 2014, while achieving RevPAR index gains versus its local competitors in the second quarter.
Clarion Pointe has already experienced a fivefold increase of its portfolio since the end of 2019, ending the first half of the year with over 30 hotels open in the U.S. and more than 20 additional hotels awaiting conversion this year.
At the same time, we rapidly grew our upscale segment.
Specifically, we've increased the number of domestic upscale rooms by nearly 25% since the end of 2019, driven by impressive growth of both Cambria and the Ascend Hotel Collection.
We also continue to invest in capabilities to further enhance our owners' value proposition and drive the bottom line results through value added programs and resources to achieve higher levels of profitability.
Notably, we enhanced our pricing and merchandising tools to further enable our franchise owners to reach their target customers and effectively drive top line revenue.
The company is currently outpacing the rate recovery seen following prior recessions.
And finally, we continue to propel our future forward by expanding our platform capabilities through signing strategic agreements with new travel partners in adjacent business segments.
These platform expansion strategies enabled us to attract new franchisees and guests to the core brand portfolio and supplement investments in strategic brand growth with increases to high margin affiliation fee streams.
As discussed on our prior calls, we've been anticipating long term consumer and demographic trends to drive a significant uptick in travel demand, and we've been making investments to capitalize on them.
Specifically, we are benefiting from trends, such as Americans rediscovering domestic destinations and the continued rise of road trips and increase in workers retiring early and the trend of work from anywhere, which affords Americans flexibility in where and when they travel for leisure.
We now know that the pandemic has only accelerated these trends, and we believe that our business will therefore benefit in an outsized way from additional travel demand coming to our key segments.
The investments we've made allowed us to capitalize on demand that has historically propelled our core business and also enabled us to attract and capture a larger share of leisure demand with customers, who are new to our brands, driving more revenue this year than in 2019.
At the same time, we're benefiting from our most loyal customers, Choice Privileges, Diamond Elite members, who are experiencing our new and refreshed brands and who contributed an even higher percentage of overall revenue for the quarter as compared to 2019.
Not only are our customers planning their travel further in advance, as witnessed by the continued lengthening of average booking windows, but we continue to see a slightly greater share of revenue coming from longer lengths of stay.
While our expectation to capture a larger share of consumers' wallet among leisure travelers is already coming to fruition, we also see continuing momentum in our business travel trends with additional runway for growth.
We have seen sequential quarter over quarter and month over month increases in our business travel booking trends in the second quarter 2021.
Likewise, with our recent refresh of the Comfort brand family and further upscale penetration, we are well positioned not only to recover our existing business customers but to expand our guest base as business travel rebounds.
As a matter of fact, our group travel bookings reached 90% of our 2019 levels in the first half of the year with key segments, strongly rebounding and lead volumes steadily rising close to 2019 levels.
The results we achieved confirm our focus to grow in our strategic segments, which will further fuel the long-term revenue intensity of our system.
I'll now provide a brief update on our key segments where all of our select service brands achieved RevPAR index gains versus their local competitors in the second quarter as compared to 2019.
Our extended stay segment, a significant growth engine for the company, expanded by over 45 hotels in the second quarter year over year and now represents over 10% of our total domestic rooms.
For the second quarter, as compared to 2019, WoodSpring Suites reported 16% RevPAR growth.
And the brand's pipeline continues to expand, reaching 155 domestic hotels.
Our suburban extended stay portfolio expanded to nearly 70 domestic hotels open, representing 15% unit growth year over year.
Additionally, franchise agreements awarded for the brand in the first half of the year exceeded levels reported in the same period of 2019.
At the same time, our MainStay Suites, mid scale extended stay brand, continued to capture nearly 14 percentage points in RevPAR index gains versus its local competitors as compared to 2019 and the brand's portfolio of over 90 domestic hotels open experienced 27% year over year unit growth.
We are especially pleased with a significant increase in developers' interest in new construction extended stay projects year over year as hotel financing begins to rebound.
The high developer activity and interest reaffirm that our strategic commitment and continued investments in this highly cycle resilient segment are driving a competitive advantage.
Our mid scale transient brands represent over two over three of our total domestic room portfolio and over half of the total domestic pipeline.
Specifically, the Comfort family achieved a RevPAR change that was nine percentage points more favorable than the upper mid scale chain scale in the second quarter as compared to 2019.
In the first half of the year, the Comfort portfolio opened the highest number of the brand's conversion hotels in the past decade, while increasing domestic new construction agreements by 20% year over year.
With newly updated properties from coast to coast, a recently refreshed brand identity and the new Rise & Shine prototype revealed this spring, the future is certainly bright for Comfort.
Our upscale portfolio achieved impressive year over year growth in the second quarter, where we increased our domestic room count by 24%, marking a record for domestic openings in the first half of the year for the company, including 22 Penn National Gaming properties.
The Ascend Hotel Collection leads the industry as the first and largest soft brand.
The brand grew its domestic room count by 28% year over year and expanded to nearly 390 hotels open around the globe.
In addition, Ascend Hotels outperformed the upscale segment RevPAR change by 26 percentage points for the quarter as compared to 2019.
Our upscale Cambria Hotels brand continues its positive momentum, growing its portfolio size by 14% to 58 units with 17 projects under active construction at the end of June and approximately 10 additional hotels planned to open this year.
These results are proof of Choice's value proposition in the upscale segment for our current and prospective owners.
The recovery is not just about travelers returning, it's also about continuing to drive forward our efforts to improve the unit economics of our franchises.
I've been traveling a lot since late March across the country.
And every time I speak with our franchise owners, they are optimistic about the progress of their business recovery and the outlook for the remainder of the year.
The close relationship we've had with our franchisees has always been strong, but the pandemic was an opportunity for us to strengthen this bond.
Specifically, our owners are very pleased with the new pricing tool we recently introduced that has helped drive their top line outperformance versus competitors and with several initiatives we launched that reduce their total cost of ownership.
Our franchisees are also benefiting from our strong business delivery.
With such a powerful value proposition, it's no surprise why Choice has an industry leading voluntary franchisee retention rate and our franchise owners continue to seek and develop our brands.
Aided by our strong value proposition for our current and future owners, we also experienced significant demand for new franchise contracts.
In the first half of the year, we awarded 200 new domestic franchise agreements, a 32% increase over the same period of 2020.
Likewise, demand for our conversion brands throughout the first half of the year has increased by over 40% year over year.
In addition, our development and franchise service team that is fully dedicated to driving diverse ownership of Choice franchise hotels among underrepresented and minority owners has awarded nearly a dozen franchise contracts in the first half of the year while growing and cultivating the number of women owners.
We also continued to strengthen our platform business portfolio, which represents a highly revenue intense extension for Choice.
Our guests are increasingly engaging with our travel partners and continuing to benefit with additional travel options, while our more than 49 million Choice Privileges members have the opportunity to earn and redeem points at our travel partners properties by booking their stays directly on choicehotels.com.
In fact, we are seeing an increase in our domestic loyalty program sign-ups in the second quarter 2021 as compared to 2019.
We are committed to enhancing our value proposition by further strengthening the platform portfolio and continuing to establish new strategic partnerships.
In closing, I'm proud to say that our culture centered around diversity, equity and belonging is being recognized.
This year, we've been named one of the best employers for diversity by Forbes, the Best Place to Work for LGBTQ equality by the Human Rights Campaign for the ninth consecutive year and one of the best places to work for people with disabilities, earning a perfect score on the Disability Equality Index for the second year in a row.
With that, I will hand it over to our CFO.
I hope you and your families are all well.
Today, I'd like to provide additional insights around our second quarter results, update you on our liquidity profile and capital allocation and share our thoughts on the outlook for the road ahead.
Throughout my remarks today, I'll provide financial performance and RevPAR comparisons to 2019, which we believe are more meaningful in analyzing trends as the prior year's quarter results were significantly impacted by the pandemic.
For second quarter 2021 as compared to the same period of 2019, total revenues, excluding marketing and reservation system fees, were $142.4 million.
Adjusted EBITDA increased 9% to $111.8 million, driven by improving RevPAR performance and continued cost discipline.
Our adjusted EBITDA margin expanded to 79%, an 8% increase.
And as a result, our adjusted earnings per share were $1.22 for the second quarter, a 3% increase versus the same period of 2019.
Let's now take a closer look at our three key revenue levers beginning with royalty rate.
The continued increases in our effective royalty rate remains a significant source of our revenue growth, which is driven by the attractive value proposition we provide to our franchisees, their continued desire to be affiliated with our proven brands and our pipeline.
The company's domestic effective royalty rate once again exceeded 5% for the second consecutive quarter, growing seven basis points for the second quarter 2021 compared to the same period of 2020, a reflection of the continued strengthening of the value proposition we provide to our franchise owners.
We expect to maintain the historical growth trajectory of this lever for full year 2021 as owners seek Choice Hotels' proven capabilities of delivering strong top line revenues to their hotels while helping them reduce their total cost of ownership and maximize return on investment.
Our domestic system wide RevPAR outperformed the overall industry by 20 percentage points for the second quarter, declining only 1% from 2019, while occupancy increased by 20 basis points as compared to the same quarter of 2019.
At the same time, our second quarter results continue to exceed the primary chain scale segments in which we compete as reported by STR by nearly seven percentage points versus 2019.
We are proud to report that our June RevPAR results exceeded 2019 levels by approximately 5%, driven by a nearly 3% increase in average daily rate and a two percentage point increase in occupancy.
The trends of improving RevPAR performance have continued into the third quarter.
Our July performance was significantly stronger with RevPAR growth of approximately 15%, driven by occupancy levels of 70% and an average daily rate increase of 10% versus 2019 levels.
In fact, July RevPAR for our upscale, extended-stay, upper mid scale, mid scale and economy segments all surpassed 2019 pre-pandemic levels.
And we saw month over month acceleration in performance across all of our segments.
These trends give us continued optimism for the remainder of the year.
As discussed in the past, we've long focused our brand strategy on driving growth across the higher value and more revenue intense, upscale, extended-stay and mid scale segments, and the investments we've made are paying off.
These strategic segments continue to help us achieve material RevPAR change outperformance against our respective industry chain scales and drove gains versus our local competitors.
Specifically, when compared to second quarter 2019, our upscale portfolio increased its RevPAR index relative to its local competitive set and outperformed the industry's RevPAR change by nearly 13 percentage points.
Our extended-stay portfolio grew RevPAR by 10% in the second quarter year over year, driven by occupancy levels of 82% and a 2% increase in average daily rate.
The segment outperformed the industry's RevPAR change by more than 31 percentage points.
And finally, the RevPAR change for our mid scale and upper mid scale portfolio exceeded these segments by eight percentage points.
Let me also highlight just a few impressive performance achievements for our brands in the second quarter as compared to the same period of 2019.
Our WoodSpring brand reported 16% RevPAR growth, reaching an average occupancy rate of nearly 86% and experiencing a nearly 6% increase in average daily rate.
Ascend Hotels grew June RevPAR by nearly 5%, driven by an over 12% average daily rate increase and achieved RevPAR index gains of 11 percentage points against their local competitors, while our Cambria Hotels drove the brand's RevPAR share gains versus their local competitors to 14 percentage points.
Quality, our largest brand in the portfolio, recorded nearly 2% RevPAR growth driven mainly by a 1.2% increase in average daily rate.
And finally, suburban extended-stay grew its occupancy by over four percentage points.
Across the Choice system, we were able to increase our overall RevPAR index against local competitors by nearly five percentage points, driven by both our franchisees' ability to grow rate and occupancy gains.
Finally, we continue to grow the overall size of our domestic franchise system and exceeded 2019 levels for conversion openings through the first half of the year.
Across our more revenue intense brands in the upscale, extended-stay and mid scale segments, we observed stronger unit growth, increasing the number of hotels and rooms by 2.5% and 3.1% year over year, respectively, and increasing the growth rate from the first quarter of 2021.
For full year 2021, we expect our overall unit growth trend to continue.
Furthermore, we continue to expect the unit growth of the more revenue intense segments to accelerate versus 2020 and range between 2% and 3%.
Aided by our strong value proposition and outperformance, demand for our brands continue to gain momentum since the beginning of the year with more than one of three of the total domestic agreements executed in the month of June.
In fact, development activity for our extended-stay and upscale domestic franchise contracts throughout the first half of the year exceeded 2019 levels by nearly 60% and 14%, respectively.
At the same time, our developers are increasingly optimistic about the long-term fundamentals of the lodging industry.
Nearly 40% of total domestic franchise agreements awarded in the second quarter were for new construction contracts, which increased by over 20% in the second quarter year over year.
In fact, demand for our new construction brands continued to accelerate throughout the first half of the year with more than half of the total new construction contracts executed in June alone.
I'd now like to say a few words about our liquidity profile and provide a capital allocation update.
Our strong results have led to an even stronger liquidity position for the company.
At the end of second quarter 2021, the company had approximately $908 million in cash and available borrowing capacity through its revolving credit facility.
We are also pleased to report cash flow from operations of $102.3 million for the second quarter of 2021, a 28% increase versus second quarter 2019.
Today, our gross debt to EBITDA leverage levels remain well within our target range of three times to four times.
Our impressive results, combined with our confidence in continuing to generate strong levels of cash and our optimism for the future led us to reinstate the quarterly dividend at the pre-pandemic level and resume our share repurchase program.
In June and July 2021, we returned over $14 million back to our shareholders in the form of cash dividends and repurchases of our common stock.
These actions reflect our continued commitment to driving long-term shareholder value and returning excess capital to our shareholders.
We will continue to monitor the environment for other investment opportunities and evaluate capital returns in the context of our leverage levels, market conditions and our overall capital allocation strategy.
Before closing, I'd like to offer some thoughts on what lies ahead.
While we are not providing detailed guidance today, we currently expect the third quarter RevPAR to grow in the mid to high single digits as compared to 2019.
Assuming elevated consumer sentiment remains and the broader RevPAR and economic recovery trends continue, we expect to see our 2021 adjusted EBITDA approaching 2019 levels, even with potential incremental investments in the back half of the year.
Our view is reinforced by our strong year to date financial performance, broader macro and consumer trends in our recent domestic June and July RevPAR results and our continued investments to support growth for the remainder of 2021 and beyond.
We will continue to evaluate the impact of COVID-19 across the business, and we'll provide further updates in November during our next earnings call.
In closing, we remain confident that our strategic approach and resilient business model coupled with our disciplined capital allocation strategy and strong balance sheet will help us further capitalize on growth opportunities and drive outsized returns for years to come.
The investments that we have made and will continue to make will allow us to execute on our ambitious long term growth plan.
At this time, Pat and I would be happy to answer any questions.
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q2 adjusted earnings per share $1.22 excluding items.
choice hotels international -not at this time providing guidance for q3 or fy given precise impact of covid-19 on co's future results is still unknown.
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They will be joined by Scott Oaksmith, Senior Vice President, Real Estate and Finance.
We appreciate you taking the time to join us.
I'm pleased to report that Choice Hotels continued to deliver strong RevPAR growth in the third quarter that once again significantly outperformed the industry.
We also continue to gain share across all segments in which we compete.
As a result of these performance trends, we expect to surpass 2019 RevPAR and adjusted EBITDA levels for full year 2021.
By continuing to implement our long-term strategy, we have positioned Choice Hotels to further benefit from post-pandemic trends that favor leisure travel, limited service hotels and longer stays.
Additionally, our business traveler demand has returned to levels similar to the third quarter of 2019.
The third quarter was exceptional, our strongest quarter of the year.
Our RevPAR increased 11.4% compared to the third quarter of 2019, surpassing our prior quarterly RevPAR guidance.
In fact, RevPAR has now exceeded 2019 levels for five consecutive months, with trends continuing into the fourth quarter.
For over 1.5 years, we've maintained significantly higher RevPAR index share gains against the competition compared to 2019.
We continued this trend in the third quarter, increasing RevPAR index versus our local competitors by nearly four percentage points as compared to 2019, reflecting continued growth in both weekday and weekend RevPAR index as reported by STR.
Choice's ability to continue to gain share even as the broader industry recovers, demonstrates that our strategic investments are paying off and gives us further confidence in our future revenue trajectory.
Because of our strategic investments, both before and during the pandemic, we are in a stronger position today to capitalize on outsized growth opportunities over the long term, which we expect will create value and drive our performance to new levels.
What's most impressive is that we continue to drive strong performance through both rate improvement and occupancy share gains.
Choice's average daily rate growth has been stronger than the industry in the third quarter due to our new revenue management tool and broader capabilities.
In addition, our robust merchandising strategy has allowed us to drive occupancy share gains versus our local competitors.
We continue to make major investments that are enhancing our owners' performance and contributing to our brand's outperformance.
Earlier this year, we launched our new revenue management capability designed to improve the ability of our franchise owners to effectively drive top line revenue.
This tool marks a step change improvement that we were able to put in the hands of our franchisees at a critical juncture in the recovery.
As the first mobile-enabled revenue management app, it allows our franchisees to more effectively manage their channels rates and inventory by adapting to local market trends in real time through repricing and competitive rate shopping multiple times during the day, and they can do this from virtually anywhere.
This enhanced capability has contributed to choice taking significant RevPAR index share specifically driving average daily rate index gains versus local competitors, and we expect this trend to continue.
The acceptance of rate recommendations by our franchisees has been significantly higher than our prior tool, demonstrating our owners' confidence in the solutions that we are providing.
This tool, combined with expert advice from our experienced revenue management consultants is helping our franchise owners to swiftly execute the right pricing strategy, which is particularly important in an inflationary environment.
At the same time, we continue to improve the unit economics for our franchisees, concentrating on investments like housekeeping upon request that lower their cost of ownership while driving continued performance improvements.
Recently, we deployed a new digital registration capability, which is integrated with our property management system.
This cost-effective cloud-based solution is designed to simplify the hotel registration process for front desk staff, save on labor, speed up check-in and improve our guests' overall experience.
Moreover, our recent brand investments are designed to appeal to the guest of tomorrow while providing a compelling return on investment for our franchisees.
Just a few weeks ago, we introduced a new Cambria hotel prototype option designed for secondary and leisure markets.
We're excited about the future growth opportunity for Cambria as we expect this prototype will allow developers the flexibility to build at a reduced cost, expanding the markets available for growth while retaining our design forward experience.
I will now provide a brief update on our key segments, where 11 out of our 12 brands achieved RevPAR index gains versus their local competitors in the third quarter as compared to 2019.
Our strategic investments in the extended-stay segment allowed us to quadruple the size of the portfolio over the past five years to reach 467 domestic units with a domestic pipeline of nearly 310 hotels.
This segment, a significant growth engine for the company, expanded by over 45 hotels in the third quarter year-over-year and now represents over 10% of our total domestic rooms.
In addition to strong unit growth, we've also driven impressive RevPAR growth across our extended stay brands.
Specifically, when compared to the third quarter of 2019, our extended-stay portfolio grew RevPAR a by over 18%, driven by occupancy levels of 82% and a 9% increase in average daily rate.
And outperformed the industry's RevPAR change by over 20 percentage points.
The WoodSpring Suites brand celebrated a key milestone with the recent opening of its 300th hotel.
The brand's pipeline expanded by over 20% year-over-year as of the end of September, reaching nearly 160 domestic hotels which further exemplifies developer demand for this brand, given its cycle resilience.
We expect that WoodSpring's robust pipeline will provide a strong platform for future growth of the brand.
Broadly speaking, we are pleased with the significant increase in developers' interest in extended stay projects.
In the third quarter, we executed two dozen extended-stay domestic franchise agreements, an 85% increase year-over-year and a 20% increase compared to 2019 levels.
In addition, the first hotel for our newest extended-stay brand, Everhome Suites is currently under construction and scheduled to open next summer, with nearly 20 additional projects already in the pipeline.
Our mid-scale brands, which represent over 2/3 of our total domestic room portfolio and approximately half of the total domestic pipeline continued to outperform the segment's RevPAR growth.
Our mid-scale and upper mid-scale portfolio grew RevPAR by nearly 10%, driven by average daily rate growth of over 9% and outpaced the industry's mid-scale and upper mid-scale segment growth by nearly seven percentage points when compared to third quarter 2019.
Our flagship brand, Comfort, recently celebrated the highest number of conversion hotel openings since 2014, while increasing new construction agreements threefold in the third quarter year-over-year.
The Comfort brand's domestic unit growth of over 2% and and RevPAR index outperformance versus local competitors demonstrate the attractiveness of this iconic brand to hotel developers and guests alike.
Our upscale portfolio achieved impressive growth in the third quarter year-over-year as we increased our domestic room count by nearly 22%, driven by both Cambria and the Ascend Hotel Collection.
The upscale portfolio also achieved a record for domestic openings in the first three quarters of the year.
The Cambria brand continued its positive momentum, growing by over 9% to 58 units year-over-year with 17 projects under active construction at the end of September, and five additional hotels planned to open this year.
In August, we celebrated the Cambria opening in the heart of one of the world's premier wine regions, Napa Valley.
Our upscale portfolio increased its RevPAR index relative to its local competitive set and outperformed the industry's RevPAR change by 15 percentage points while increasing the average daily rate by 11% when compared to the third quarter of 2019.
This progress shows the attractiveness of Choice Hotels value proposition in the upscale segment for current and prospective owners.
The strong performance across our entire brand portfolio confirms our focus on growing in our strategic segments which we believe will further fuel the long-term revenue intensity of our system.
Turning now to demand trends.
We continue to achieve gains in our weekday occupancy index share during the third quarter compared to 2019.
As discussed on our prior calls, we believe that these share gains are partially driven by long-term consumer trends, such as remote work and an increase in early retirements, which afford Americans flexibility as to when and where they travel for leisure.
In fact, we observed our guests extending their trips into shoulder days of the weekend, giving us further optimism about future travel trends following the historically busy summer travel season.
In addition, we continue to observe a greater share of revenue coming from longer stays as compared to 2019.
Similar to our broader occupancy share gains, these weekday demand gains were achieved through our merchandising capabilities and strategy with targeted promotions at the right time of the week, during the right time of the year and for the right customer.
The investments we've made have allowed us to capitalize on demand that historically propelled our core business while attracting and capturing an even larger share of leisure demand.
While our most loyal Choice Privileges members continue to spend more at our hotels during the third quarter, we were also successful in appealing to those who are new to our brands, increasing their revenue contribution as compared to 2019 levels.
We also see continuing momentum in our business travel trends, with anticipated additional runway for growth.
We've continued to witness sequential quarter-over-quarter increases in our business travel bookings in the third quarter of 2021, with overall business performance similar to 2019 levels.
As a company with a strong emphasis on a customer-first approach, Choice is always looking for innovative ways to better serve the changing needs of today's consumers and anticipate the expectations of the guest of tomorrow.
For example, we are the first lodging company to launch a collaboration with Bakkt a trusted digital asset marketplace, enabling us to cater to guests with more currency options and more ways to redeem this currency.
Our more than 50 million Choice Privileges loyalty members can now unlock new redemption opportunities by converting their rewards points to cash and then use it to buy Bitcoin, transfer their points to a friend or even redeem them online or in-store anywhere, Apple Pay or Google Pay is accepted.
Turning now to our franchisee business delivery and demand for our brands.
In addition, we drove growth as compared to 2019 and 2020 through increased revenue contribution in the third quarter from choicehotels.com and other proprietary digital channels.
Business delivery through these channels significantly improves our owners' profitability as they deliver strong rates at the lowest cost.
As a result, these channels remain a key focus area for enhancing our value proposition.
With such a powerful value proposition, it is no surprise why Choice maintains an industry-leading franchisee voluntary retention rate and our franchise owners continue to seek and develop our brands.
Aided by our strong value proposition for our current and future owners and our record outperformance, we also continue to experience demand for new franchise contracts.
In the third quarter, we awarded 89 new domestic franchise agreements, a 10% increase over the same period of 2020.
Specifically, we're very pleased to see that demand for our new construction brands in the third quarter increased by over 50% year-over-year.
And we are also excited to announce that our WoodSpring brand expanded internationally at the end of October, entering the Canadian market with a more than 15 unit commitment from a well-known developer and operator.
In addition, a team within our development and franchise service departments that is fully dedicated to driving diverse ownership of Choice franchise hotels among underrepresented and minority owners has awarded 18 franchise contracts year-to-date through September, bringing the total agreements executed to over 280 since the program began over 15 years ago.
I'm proud to say that more than half of the 18 agreements this year were awarded to women entrepreneurs.
None of these accomplishments would have been possible without the resilience and hard work of our dedicated associates.
We are committed to continuing to invest in and support our associates, and we are proud to be the hotel industry's only company to recently earn recognition as a Best Work-life Balance Employer by Comparably.
In closing, I'm confident in our continued ability to create value and deliver results for our owners and shareholders through our effective strategic investments, impressive performance and award-winning culture centered around diversity, equity and belonging.
With that, I will hand it over to our CFO.
I hope you and your families are all well.
Today, I'd like to provide some additional insights on our third quarter results, update you on our liquidity profile and capital allocation and share our thoughts on the outlook for what lies ahead.
As we discussed in the previous quarter, we are comparing our financial performance and RevPAR results to 2019, which we believe offers a more meaningful basis for analyzing trends as the prior year's quarterly results were significantly impacted by the pandemic.
For third quarter 2021 as compared to the same period of 2019, total revenues, excluding marketing and reservation system fees, were $166.5 million, an 8% increase.
Adjusted EBITDA rose 18% and to $133.2 million, driven by improving RevPAR performance, revenue intense unit growth and strong effective royalty rate growth, coupled with continued cost discipline.
Our adjusted EBITDA margin expanded to 80%, a rise of seven percentage points.
And as a result, our adjusted earnings per share were $1.51 in for the third quarter, an increase of 10% versus 2019.
Let's now turn to our three key revenue levers beginning with royalty rate.
Our effective royalty rate remains a significant source of our revenue growth.
The company's domestic effective royalty rate increased by eight basis points year-over-year to approximately 5% compared to the third quarter of 2020.
This performance reflects the continued strengthening of the value proposition we provide to our franchise owners, their continued interest in being affiliated with our proven brands and the promising prospects in our pipeline.
It also provides further validation of our long-term past, current and future investments on behalf of our franchisees.
We expect to maintain the current growth trajectory of this lever for full year 2021 and grow at our historical rate in the future as owners continue to seek Choice Hotels' proven capabilities of delivering strong top line revenues that maximize return on investment while helping them reduce their total cost of ownership.
Our domestic systemwide RevPAR outperformed the overall industry by 16 percentage points for the third quarter, increasing 11.4% over 2019.
Specifically, our average daily rate grew by nearly 9%, and our occupancy levels increased by nearly two percentage points compared to the same quarter of 2019.
Our third quarter results showed that we continue to outpace the primary chain scale segments in which we compete as reported by STR by six percentage points versus 2019.
Importantly, our strong RevPAR trends have continued into the fourth quarter.
As you know from our prior calls, we've long focused our brand strategy on driving growth across the higher value and more revenue intense, upscale, extended-stay and mid-scale segments.
The investments we've made continue to pay off as these strategic segments have enabled us to materially outperform the industry in RevPAR growth and achieve gains versus our local competitors.
Let me highlight just a few impressive performance achievements for our brands in the third quarter.
Just a reminder, we're comparing the growth figures with the same period of 2019.
Our WoodSpring brand achieved 23% RevPAR growth, reaching an average occupancy rate of nearly 86% and experiencing an 11% increase in average daily rate.
Ascend Hotels saw their growth in average daily rate of over 17% and outperformed the upscale segment's RevPAR growth by over 20 percentage points.
At the same time, the Comfort family grew RevPAR by over 8% on reflecting a 9% increase in average daily rate.
Finally, both our Cambria and MainStay Suites brands captured 12 percentage points in RevPAR index gains versus their local competitors.
More specifically, our average daily rate and occupancy improved from the prior quarter, and our average daily rate index and occupancy index continue to increase compared to 2019 as a result of our investments in revenue management tools for our franchisees and the merchandising capabilities and strategy we have put in place.
Our third revenue lever is units and rooms growth, which benefits from the absolute size of our portfolio and the revenue intensity of the totals.
To ensure the quality of our brand portfolio over the long term, we continue to terminate underperforming economy hotels at the bottom end of the portfolio as well as quality hotels that are unable to maintain the standards of a mid-scale brand.
We believe that these actions will not only ensure an even stronger brand portfolio over the long term, but we also expect these targeted terminations to be an opportunity for royalty revenue growth as we plan to replace these hotels with higher quality and more revenue-intense units.
Nevertheless, we continue to grow the overall size of our domestic franchise system.
Across our more revenue intense brands in the upscale, extended-stay and mid-scale segments, we observed stronger unit growth, increasing the number of hotels by 2% and rooms by 2.6% year-over-year.
Our developers are increasingly optimistic about the long-term fundamentals of the lodging industry.
In fact, 1/3 of total domestic franchise agreements awarded in the third quarter were for new construction contracts representing an increase of more than 50% versus the same quarter of the prior year.
At the same time, demand for our conversion brands year-to-date through September increased by 25% year-over-year.
Let me share a few highlights on specific brands.
The Ascend Hotel Collection leads the industry as the first launch and today, the largest soft brand expanding its domestic room count by 27% year-over-year.
At the same time, Clarion Point has nearly doubled its portfolio year-over-year ending the third quarter with nearly 35 hotels open in the U.S. and 15 additional hotels awaiting conversion this year.
Our MainStay Suites mid-scale extended-stay brand portfolio expanded to nearly 100 domestic hotels open, representing more than 30% unit growth year-over-year.
And finally, our suburban extended stay portfolio of 70 domestic hotels open experienced 13% year-over-year unit growth.
Now a few words about our liquidity profile and an update on capital allocation.
As a result of our strong performance, the company has an even stronger liquidity position.
More specifically, at the end of the third quarter of 2021, the company had over $1 billion in cash and available borrowing capacity through its revolving credit facility.
We are also pleased to report cash flow from operations of $142.8 million for the third quarter 2021, a 53% increase versus the third quarter 2019.
Today, our gross debt-to-EBITDA leverage levels remains at the low end of our target range of three to 4 times.
At the end of third quarter 2021, our net debt-to-EBITDA leverage level was at 1.8 times.
These impressive results combined with our strong liquidity and confidence in our ability to generate strong levels of cash, leave us well positioned to continue to grow our business and return excess cash flow to shareholders well into the future.
Year-to-date through October, we have returned over $35 million back to our shareholders in the form of cash dividends and repurchases of our common stock.
We will continue to monitor the environment for other investment opportunities and evaluate capital returns in the context of our leverage levels, market conditions and our overall capital allocation strategy.
Finally, let's turn to our expectations for what lies ahead.
We currently expect full year domestic RevPAR to surpass 2019 levels and grow at approximately 1% as compared to full year 2019.
Assuming the broader RevPAR and economy recovery trends continue, we now expect to see our 2021 adjusted EBITDA exceed 2019 levels and range between $382 million and $387 million, even with planned incremental investments in the fourth quarter.
Our view is reinforced by our third quarter results which extend our strong year-to-date financial performance, broader macro trends and our continued investments to support growth for the remainder of 2021 and beyond.
We will continue to evaluate the impact of COVID-19 across the business, and we'll provide further updates in February during our next earnings call.
In closing, we remain confident in our long-term strategic approach and resilient business model, coupled with our disciplined capital allocation strategy and strong balance sheet, we believe these strengths will allow us to further capitalize on growth opportunities and drive outsized returns for years to come.
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q3 adjusted earnings per share $1.51 excluding items.
q3 revenue rose 4 percent to $323.4 million.
domestic revpar for 2021 expected to surpass 2019 levels and grow at approximately 1%, as compared to full-year 2019.
adjusted ebitda for 2021 is expected to exceed 2019 levels and range between $382 million and $387 million.
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Molly Langenstein, our CEO and president, also joins me today.
You should not unduly rely on these statements.
I'm excited to share our second-quarter results as they underscore the incredible progress we continue to make in our turnaround strategy despite pandemic challenges.
Our earnings per share of $0.21 is the best second-quarter performance we have posted since 2013.
This return to profitability was driven by our turnaround action plan that grew sales, expanded gross margin, and diligently controlled our expenses.
Our robust second-quarter sales growth of 54% was across all three brands and was propelled by our meaningful enhancements in product and marketing, which continues to significantly drive full-price selling, reduced markdowns, and increased gross margin.
Soma achieved the highest second-quarter sales results in the brand's history.
Not only did Soma post a 53% sales growth over last year's second quarter, comparable sales grew a remarkable 38% over the second quarter of 2019.
In fact, we have had four consecutive quarters of comp growth at Soma.
Congratulations to the Soma team.
Soma remains on track to delivering an incremental 100 million in sales this year.
According to NPD research data, Soma's growth outpaced the market in non-sports bras, panties, and sleepwear for the past 12 months compared to the same period in 2019.
In addition, as customers' preferences have shifted to comfort, soma strategically increased its wireless bra assortment, taking more market share than any other brand for the last 12 months compared to the same period in 2019.
We believe this data, along with our recent performance, is a strong indication that Soma is well-positioned to capture additional market share and explode into a billion-dollar brand by 2025.
The business strategies put in place in Soma around inventory, product, marketing and digital are working.
And we are confident applying this proven playbook at Chico's and White House Black Market will continue their sales momentum.
Exciting things are indeed happening at both Chico's and White House Black Market, as indicated by second-quarter sales growth of 59% and 48%, respectively.
At both apparel brands, customers are enthusiastically responding to our elevated quality and styling enhancements, which are leading to meaningfully faster sell-through rates, higher productivity and more full-price sales and better-maintained margins.
Our second-quarter results once again highlight the incredible progress we are making on our five strategic priorities.
So let me take a few minutes to update you on each.
Priority number one, continuing our ongoing digital transformation.
Over the last two and a half years, we have successfully transformed into a seamless digital-first, customer-led company, adding resources and making strategic investments in talent and technology.
We have been thrilled with the trajectory of our digital sales over this time frame.
As our store revenues continue to rebound, our second-quarter digital sales grew 23% over 2019 levels.
Style Connect and My Closet continue to gain traction.
And customers using this proprietary digital tools are more engaged and have our highest conversion rates, UPTs, and average order values.
These tools continue to drive new multichannel customer growth, and these customers are our most valuable, spending more than three times a single-channel customer.
Afterpay, the popular benefit launched in time for holiday last year, allowing for customers to pay for their purchases in installments, has also proven to be a terrific UPT and sales driver and is beating our expectations.
Priority two, further refining products through styling, fabric, and innovation.
At each of our brands, we are leveraging customer data and insights, and continually elevating our product to take market share and drive results.
Customers are clearly responding across all three brands.
Continual newness and creating comfortable, beautiful solutions are core to the Soma brand.
We are feeding a conveyor belt of innovation for wireless and sports bras, ensuring she has the absolute right bra for everything she does in her life.
Sleepwear and panties continue to be strong and drove double-digit growth over last year and 2019 levels.
Chico's customers are continually responding to our newness, comfort features, novel technology, and innovative fabrics with pronounced acceleration in the quarter in denim, pants, dresses, knits, and woven tops.
White House Black Market also continued to benefit from elevated styling and quality improvements, and customers responded to our new pants and short programs as well as knits and dresses.
Congratulations to the apparel teams for a great quarter.
Next, driving significant increased customer engagement through digital storytelling.
Through our enhanced customer data analytics and insights, we have elevated and targeted our marketing efforts, which are driving brand awareness, generating traffic, and acquiring new customers.
We continue to allocate more resources to digital storytelling, social influencers, and other social efforts.
Our social media customer engagement continues to grow and customers are responding to influencers and associates.
We continue to acquire new customers and their average age continues to trend younger than existing customers, which reinforces the runway for all three brands.
Priority four, maintaining our operating and cost discipline.
Our most meaningful second-quarter accomplishment was our gross margin performance.
In fact, we posted our highest gross margin rate in 13 consecutive quarters.
This was driven by strength in full-price sales and the corresponding reduction in promotions.
Our on-hand inventories remain strategically lean, down 27% versus last year's second quarter and down 20% compared to the second quarter of 2019.
Scarcity of products and social proofing continued to drive a sense of urgency for customer purchasing.
These factors should continue to strengthen gross margin performance.
However, we are facing certain headwinds in the back half of the year that will impact gross margin and sales, including cost pressures from logistics, sourcing, fulfillment, and the labor market.
These considerations are included in our guidance that David will cover later in the call.
And finally, our last priority, delivering higher productivity in our real estate portfolio.
We delivered strong store growth during the quarter, and stores continue to be an integral part of our overall strategy as data indicates that digital sales are higher in markets where we have a strong retail presence.
Prudent store growth makes sense where the investment delivers profitable returns.
We have successfully opened 47 Soma shop-in-shops inside Chico's stores, which are exceeding expectations, driving new customers to both brands, and further expanding our digital business.
More of these shop-in-shops are scheduled going forward with a total of 70 expected by first quarter of next year.
At the same time, we continue to rationalize and tighten our real estate portfolio for higher store productibility standard.
Accordingly, we will continue to shrink our store base, primarily as leases come due, lease kickouts are available or buyouts make economic sense.
We have lease flexibility with nearly 60% of our leases coming up for renewal or kick out available over the next two to three years.
We are still on track to close 13% to 16% of our remaining store fleet through the end of fiscal 2023, with 45 to 50 of those closures occurring this fiscal year.
During the quarter, we closed nine stores, bringing our year-to-date closings to 18, and we ended the quarter with 1,284 boutiques.
We are very pleased with our company's return to profitability, posting diluted earnings per share of $0.21 for the second quarter, compared to a $0.40 loss per share from last year's second quarter and a $0.02 loss per share for the second quarter of fiscal 2019.
Q2 is our best quarter earnings performance since 2013.
Second-quarter net sales totaled $462 million compared to $306 million last year.
This 54% increase reflects meaningful improvement in product and marketing, which drove full-price selling as well as a recovery in-store sales as our stores were temporarily closed or operating at reduced hours last year, partially offset by 29 net store closures in the last 12 months.
Looking at the second quarter compared to 2019, our comparable sales were basically flat, declining just 1.6% with Soma improving 38% and Chico's and White House Black Market declining 14% and 5%, respectively.
Total company on-hand inventories compared to 2019 declined 20%, with Soma up 19%; and Chico's and White House Black Market down 32% and 49%, respectively, illustrating that the strategic investments in Soma's growth and our turnaround strategy in Chico's and White House Black Market are working.
Second-quarter gross margin was 38.4% compared to 14.6% last year, which included the impact of significant non-cash inventory write-offs.
This year, we meaningfully expanded our margin rate as a result of disciplined inventory control, strategically reduced promotions, and more full-price selling.
This was our highest gross margin rate in 13 consecutive quarters.
SG&A expenses for the second quarter totaled $146 million or 30.9% of sales, an improvement of more than 400 basis points from last year's second quarter and nearly 300 basis points better than the second quarter of 2019.
We have continued our cost discipline and reduction initiatives, enabling us to realize leverage in the current year.
Regarding our financial position, we continue to build cash, and our balance sheet continues to strengthen.
We ended the quarter with over $137 million in cash and marketable securities, an increase of nearly $35 million over the first quarter.
Borrowings on our $300 million credit facility remained unchanged from fiscal year end at $149 million.
Our financial position liquidity continues to be bolstered by improving retail sales and a lean expense structure that better aligns cost with sales.
In addition, during the second quarter, we received a $16 million income tax refund related to the $55 million income tax receivable reported in the first quarter, and we expect to receive the balance of the $55 million in the third quarter.
We anticipate building cash throughout the remainder of fiscal 2021.
In the second quarter, we continued our lease renegotiation initiatives with A&G Real Estate Partners, securing year-to-date commitments of approximately $15 million, and incremental savings from landlords, the majority of which will be realized this fiscal year.
This is in addition to the $65 million in abatements and reductions negotiated last year for a total savings to date of $80 million.
Now turning to our outlook.
During the balance of fiscal '21, we expect improving year-over-year demand, but recognize that there is economic uncertainty as we continue to manage through the pandemic.
In addition, we are facing macro supply chain headwinds in the back half of the year that we expect will impact sales and gross margin, including higher freight cost, extended transit times, and product supplier handover delays driven by the pandemic.
Accordingly, given this uncertainty, we are not providing specific guidance, but instead offering high-level outlook expectations for the third quarter and fiscal year.
For the third quarter, we expect consolidated year-over-year sales improvement in the 18% to 22% range, gross margin rate improvement of 13 to 15 percentage points over third quarter last year, SG&A as a percentage of sales to improve 500 to 600 basis points year over year and an income tax rate of 34% to 35%.
For the full fiscal year, we expect consolidated year-over-year net sales improvement in the 32% to 35% range, gross margin rate improvement of 20 to 22 percentage points over fiscal 2020, SG&A as a percent of sales to improve 500 to 600 basis points year over year and an income tax rate of 34% to 35%.
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compname posts q2 earnings per share $0.21.
q2 earnings per share $0.21.
compname says consolidated year-over-year net sales improvement between 18% to 22% for q3.
compname says expects consolidated year-over-year net sales improvement between 32% to 35% for fy 2021.
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You should not unduly rely on these statements.
He comes to us with a wealth of retail financial experience and we are pleased to have him on board and on the call today.
We achieved another great quarter and the momentum continues.
Third quarter earnings per share of $0.15 repr-+esent the companies best third quarter performance since 2016 and demonstrates the extraordinary progress we continued to make in our turnaround strategy.
The return to third quarter profitability was driven by healthy year over year comparable sales growth meaningful gross margin expansion.
In fact, the best third quarter gross margin performance since 2014 and continued diligence expense management.
The robust year-over-year third quarter comparable sales increase of 28% was driven by significant digital and store outperformance across all three brands propelled by the meaningful quality, fit, and fabrication enhancements in our products.
We have continued to significantly drive full-price selling, reduce markdowns and increase gross margin quarter-over-quarter.
Dramatic improvement is continuing at Chico's and White House Black Market as indicated by our third quarter comp sales increase of 23% and 33% respectively on significantly lower inventory levels.
Both apparel brands are driving meaningfully faster sell-through rates, higher productivity, more full-price sales, and better-maintained margins.
Existing and new customers are enthusiastically responding to our updated fabric, fit, and new product offering.
The apparel brands generated their best third quarter gross margin performance in more than five years.
Soma posted a 30% comp sales increase over last year's third quarter on top of an 11% comp sales increase in the third quarter of 2019.
Marking five consecutive quarters of comp sales growth.
To continue driving this business forward, we have invested in the necessary inventory capital and staffing.
Twelve months of trailing data from market research NPD Group shows that solid growth continues to outpace the market in non-sports bra, panties, and sleepwear.
We believe this data along with our recent performance is a strong indication that Soma is well-positioned to continue capturing additional market share on our journey to becoming a billion-dollar brand.
Our third quarter performance highlights the remarkable progress we are making on our five strategic priorities.
Let me take a few minutes to update you on each.
First, continuing our ongoing digital transformation.
Over the last two and a half years we have successfully transformed Chico's FAS into a seamless digital-first customer-led company as evidenced by the trajectory of our digital sales over this time.
Even as store revenues have continued to rebound.
Digital sales have remained very strong.
The investments we have made in talent and technology have paid off.
Our proprietary digital tools continue to gain traction.
And customers using these tools are more engaged and have higher conversion rates and average order value.
These tools continue to drive year-over-year new multi-channel customer growth and these customers are our most valuable spending three times a single-channel customer.
We continue to leverage our online outfitting experiences, style connect in my closet, and customer engagement growth every quarter.
Approximately 3 million customers representing nearly half of our active customer file are now enrolled in file connect.
My closet is a personalized experience enabling customers to augment their closet by coordinating their wardrobe for past purchases.
Generates conversion at four and a half times the site average and significantly higher average order value than those not using the feature.
We are continually enhancing our personalization efforts to drive engagement, conversion, and orders, including our Shop The Look feature launched last year.
After pay allowing for customers to pay for their purchases in installments has also proven to be a terrific UPT and sales driver.
Since it launched about a year ago.
It continues to exceed our expectations.
Buy Online Pick Up in the store has also remained popular and is still growing double-digit.
Second, further refining our product.
On the product front, we are doing two key things at each of our brands to take market share and drive results.
First, leveraging our customer data and insights.
And second, constantly innovating and elevating our assortment.
Customers are clearly responding across all three brands.
At Chico's, denim and our new pant selections are a big hit, which she is pairing with wovens, sweaters, and our great no-iron shirt to make a complete outfit.
She is responding to our elevated fabrics and new comfort features in bottoms.
White House black market continues to benefit from elevated styling and quality improvements as well.
We had an outstanding response to our new denim fit and fabric with year-over-year denim revenues nearly doubling for the quarter.
She is pairing denim with our three new key White House Black Market jackets silhouette that is versatile for every occasion.
Continually creating comfortable beautiful solutions are core to the Soma brand.
We offer a full broad menu of solutions so she can find the absolute right bra for all of her needs.
Year over year bra revenues was up 38% in the quarter boosted by the fact that our customers returned to the stores or in-person fittings.
Sleepwear and panties continue to be strong and drove double-digit growth over last year and 2019 levels.
Next driving customer engagement.
Through enhanced customer data analytics and insight, we have elevated and targeted our marketing efforts, which are driving brand awareness, generating traffic, and acquiring new customers.
We continue to allocate more resources to digital, storytelling influencers, and other social efforts.
We are elevating our content including using more organic and user-generated content.
Our social media customer engagement continues to grow and customers are responding.
For example, our weekly Facebook live selling events are engaging and continue to gain traction and generate sales.
In the third quarter, our apparel brand had over 2.3 million views in social selling live videos and real.
We continue to acquire new customers with the customer count up nearly 8% from the prior-year third quarter.
And their average age continues to trend younger than existing customers.
This data reinforces the runway for all three brands.
Priority for maintaining our operating and profit discipline.
One of our most meaningful third quarter accomplishments was our gross margin performance.
We achieved our highest third quarter gross margin rate since 2014, driven by strength in full-price sales and the corresponding reduction in the promotion, strategic inventory management, and improved leverage of occupancy cost on higher sales.
Continued cost discipline efforts and sales leverage resulted in the third quarter SG&A and rate lower than both the third quarters of 2020 and 2019.
In fact, we posted our best SG&A rate performance since 2018.
And finally, delivering higher productivity in our real estate portfolio.
Door traffic was very healthy and we delivered strong store sales growth during the third quarter.
Stores continue to be an integral part of our overall strategy as data indicates that digital sales are higher in markets where we have a strong retail presence.
Food and store growth for the portfolio brands makes sense where the investment delivers profitable returns.
We have successfully opened 64 Soma shop-in-shop inside Chico's stores, which are exceeding expectations, driving new customers to both brands, lifting store productivity, and further expanding our digital business.
We plan to open nine more shops-in-shop in the fourth quarter.
At the same time, we continue to rationalize and tighten our real estate portfolio as appropriate in order to deliver overall higher store profitability.
We will make decisions to close stores when it is accretive to the overall portfolio.
This remains a dynamic process.
For example, at the beginning of the year, we expected to close 45 to 50 locations.
This fiscal year but have reduced that number to 37 due to a combination of favorable store performance and successful lease negotiation.
I'm excited to be part of Chico's team and look forward to engaging with all of you in the investor and analyst community.
Our momentum continued in Q3 and we posted another quarter of profitable growth with diluted earnings per share of $0.15 for the quarter, compared to a $0.48 loss per share in last year's third quarter and a $0.7 loss per share for the third quarter of fiscal 2019.
I will note that on a non-GAAP basis before onetime charges diluted earnings per share for the quarter was $0.18.
This year's third quarter marks our best third quarter earnings performance since 2016 with all three brands leveraging a shared platform contributing meaningfully to sales growth, gross margin expansion, and significantly higher operating income.
Third quarter net sales totaled $453.6 million, compared to $351.4 million last year.
This 29% increase reflects a comparable sales increase of 28% and is driven by meaningful improvement in product and enhanced marketing efforts, which drove full-price selling partially offset by 31 net store closures in the last 12 months.
At the brand level, Chico's comparable sales grew 23%, White House Black Market comp sales grew 33.4%, and SOMA comp sales grew 30.2% over 2020.
Looking at the third quarter compared to 2019, our comparable sales continue to improve reaching close to 97% of pre-pandemic 2019 levels with Soma increasing 44% in Chico's and White House Black Market down 16% and 5% respectively.
I would note that this level of sales growth was achieved with much lower on-hand inventories compared to 2019 with Chico's inventories down 46% and White House Black Market inventory is down 39%.
Reinforcing the higher productivity achieved by managing inventory with a focus on overall profitability.
The third quarter gross margin was 40.7%, compared to 22% last year, and 35.3% in 2019.
The current year gross margin rate was our best performance in 18 consecutive quarters and reflected higher full-price sales and improved occupancy leverage.
This improvement was achieved despite supply chain challenges and related costs that continue to impact the retail sector.
Moving down the P&L, SG&A expenses for the third quarter totaled $162.5 million or 35.8% of sales, compared to 43.6% of sales in 2020, and 37.3% of sales in 2019.
Continued cross-discipline and expense reduction initiatives coupled with improving sales have enabled us to realize meaningful leverage that would give us more financial flexibility as we continue to grow all three brands.
On a year-to-date basis, I would like to highlight that both profitability and cash flow have improved significantly since last year and 2019.
In addition to giving us much more flexibility, higher free cash flow generation will provide us with fuel to invest behind a strategy that is working.
Fueling growth will be a key capital allocation priority going forward.
On a year-to-date basis, we generated $89 million of EBITDA through the third quarter, which is significantly higher than EBITDA of $65 million for all of fiscal 2019.
For the current year nine months, we posted earnings per share of $0.29, compared to a loss of $2.43 per share in the prior year nine months, and a loss of $0.7 for the same period in 2019.
Now let's shift to the balance sheet.
Our cash position and total liquidity remain strong.
Providing us with the flexibility to manage the business and make investments to further fuel our momentum.
We ended the quarter with cash and marketable securities of $137.5 million.
A slight increase over the second quarter balance even after reducing borrowings on our long-term credit facility by a third with a $50 million debt repayment.
On hand inventories for the quarter remain very lean down 13% relative to 2020 and down 19% relative to 2019.
Our inventory has never been more productive and delivered a very high gross margin for us especially in the apparel brands where on-him inventory was down 38% to last year and down 43% to 2019.
Turning to real estate.
In the third quarter, we continued our lease renegotiation initiative with A&G Real Estate Partners securing incremental commitments of $7 million bringing our total year-to-date commitments to $22 million in rent reductions from landlords.
This is in addition to the 65 million introductions negotiated last year for a total savings of $87 million since we commenced the renegotiation program in 2020.
These renegotiated store leases will provide an occupancy tailwind and further enhance store profitability going forward.
As Molly noted, we are continuing to right-size our store base.
Primarily at leases come due lease checkouts are available for buyouts make economic sense.
We have flexibility with approximately 60% of our leases coming up for renewal for kick-outs available over the next two to three years.
During the third quarter, we closed five stores bringing our year to date closing to 23 and we ended the quarter with 1,279 boutiques.
Going forward, we will continue to actively manage our real estate portfolio to enhance overall store profitability.
Now turning to our fourth quarter outlook, given the strength of customer demand for all three of our brands, we are confident that our momentum will be sustained as we get further into the quarter.
We expect fourth quarter total sales to continue to accelerate closer to 2019 and reach $495 million to $510 million.
We expect fourth quarter gross margin rate as a percent of sales to be a part of 2020 and 2019 and in the range of 33% to 34.5%.
This expectation incorporates continued inventory management with faster sell-through rates and higher full-price sales as well as higher supply chain costs.
We are continuing to manage our expense structure and expect that the SG&A rate as a percent of sales to be in the range of 32.3% to 32.8%.
We expect our effective tax rate to be approximately 33% for the quarter, which will give us a rate of 24% for the full year.
And we expect to deliver dilutive earnings per share a flat to $0.5 for the fourth quarter putting us well above 2020 and 2019 for both the quarter and the full year.
Before we go on to Q&A, I would like to leave you with three key thoughts.
First, our turnarounds have accelerated due to our strategic initiatives and continued cost discipline.
Second, all three of our brands are contributing meaningfully to sales growth and profitability.
And last, we have greatly improved the fundamental operating model of the business and have created a sustainable tailwind that will allow us to successfully navigate the current macro environment and continue on a path of profitable growth well into the future.
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compname reports q3 earnings per share of $0.15.
q3 earnings per share $0.15.
q3 adjusted earnings per share $0.18 excluding items.
q3 sales $453.6 million versus $351.4 million.
sees consolidated net sales of $495 million to $510 million in q4.
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Molly Langenstein, our CEO and president, also joins me today.
Although 2020 and pandemic uncertainty created a sales environment that was challenging as reflected in our results, we successfully navigated this extraordinary landscape while also creating a solid foundation that we believe positions us for our return to growth in 2021 and the years ahead.
We rapidly accelerated our transformation to a digital-first company, fast-tracking numerous innovation and technology investments, which drove higher consumer engagement and year-over-year digital sales increase of nearly 20%, led by Soma's digital sales increase of 72%.
As a brand, Soma generated comparable sales growth for the last seven months in fiscal 2020.
And according to the NPD Group, for the 12 months ended January 2021, Soma's growth exceeded that of the U.S. apparel market and the market leader for nonsport bras and panties and was in the top five brands overall in the sleepwear market.
I am also pleased to report that Soma sales for the back half of fiscal 2020 were the highest in the history of the brand.
We believe this is compelling evidence Soma is well positioned to accelerate recent market share gains.
Our enhanced marketing efforts drove traffic as well as new customers to our brands, and newly acquired customers were retained at a meaningfully higher rate than fiscal 2019.
The average age of our new customers dropped 10 years for Chico's and eight years for Soma.
And the average age for the new White House black market customers complemented the current target customer, reinforcing the runway for all three brands.
Our new apparel selections resonated with customers.
We relaunched Zenergy in Chico's with new fabrication, styling and marketing and also increased our gifting assortment in key item depth, which showed positive results.
At White House black market, we pivoted to casualization and launched Lux Weekend, new runway leggings and a focus on denim that customers love.
We significantly enhanced our liquidity and financial flexibility by amending and extending our credit facility to $300 million and ended the year with a solid cash position.
We obtained landlord commitments of $65 million in rent abatements and reductions and further rationalized our real estate position by permanently closing 40 underperforming locations over the last year.
And we substantially streamlined our organization and permanently reduced our cost structure to more efficiently support our business.
These efforts resulted in approximately $235 million of annual savings in fiscal 2020 or 23% greater than our original plan.
Chico's FAS is a company of three unique brands, and we believe we are poised to take market share in each of these businesses when the pandemic-related consumer pause lifts.
We are optimistic about store traffic rebounding as vaccines become more widely available and have, in fact, seen this correlation prove out.
We believe Soma, in particular, has the opportunity for significant growth.
Today, the intimate apparel and loungewear market is a nearly $7 billion business in the U.S. and is forecasted to reach over $11 billion by 2025.
Soma's compelling position in intimates and a seven month of comparable sales growth, give us confidence that Soma is on track to take a meaningful piece of this market and become one of the largest intimate apparel brands in the country.
At the same time, we believe there is opportunity to optimize and strengthen both Chico's and White House black market.
The disruption in the competitive set has left white space that we can strategically take.
At Chico's, we expect to reinvigorate growth through loyalty, community and design.
At White House black market, we expect to drive consumer enthusiasm for the brand by a focus on fabric, fit and fashion that meets our customer where she is in her lifestyle today.
In order to maximize the opportunities in each of our brands, we are targeting five key focus areas for 2021.
First, continuing our ongoing digital transformation.
Second, further refining product through fit, quality, fabric and innovation.
Third, driving increased customer engagement through marketing.
Number four, maintaining our operating and cost discipline and finally, further enhancing the productivity of our real estate portfolio.
Allow me to elaborate on each of these.
Number one, continuing our ongoing digital transformation.
Over the last year and a half, we prioritized digital as the primary sales channel for all three of our brands, making major strategic investments in talent and technology to pivot up to a digital-first company.
We are enabling her to shop how she chooses in a way that is personalized and simplified across every touch point of her shopping experience.
Innovative launches that we consider meaningful competitive advantage includes Style Connect, our digital styling tool; My Closet, a personal closet feature; and social proofing.
Each of these tools have gained traction and driven engagement and conversion.
In the fourth quarter, Style Connect orders nearly doubled from last year.
We have successfully enrolled 42% of our active customer file in Style Connect, representing almost three million customers.
Our prioritization to digital also incorporates mobile POS, AI search engine optimization and enhanced navigation touch points across all brands.
We have also accelerated the launch of new leading edge digital selling and fulfillment tools to drive greater online customer demand.
We will be rolling out more innovations in 2021, including an optimized mobile-first experience.
We continue to leverage our digital investments, converting single channel customers to the omnichannel customers as the average omnichannel customer spend is nearly three and a half times more than a single channel customer.
Number two, further refining products through fit, quality, fabric and innovation.
At each of our brands, we are laser-focused on our customer, continually elevating our products so we can capture the greatest market share.
At Soma, innovation is at our core, while beautiful solutions that extend to wellness and comfort are synonymous with our brand.
Our products serve our customers' lifestyle and promote health, including a great night sleep and loungewear to live in.
We fuel our bra and panty franchises and are positioned to further expand our market share and drive results.
We have a growing customer base with the most meaningful growth in our under 34 age group, as a result of more inclusive branding and evolved product assortment.
To continue capturing a broader audience, we will integrate our digitally native and younger TellTale brand onto the Soma site, which we successfully tested in the fourth quarter.
At our apparel brand, as the world shifts toward comfort and work from home, we see increased interest in our core franchises of effortless chic pants and tops at Chico's and denim with plenty of stretch, legging and feminine tops at White House black market.
As women emerge from their homes and continue to reinvent their wardrobe, we have developed improved fabrics and integrated new technology and comfort features to adapt to her needs.
Number three, driving increased customer engagement through marketing.
Our goal is to increase brand awareness, drive engagement, generate traffic and acquire new customers through continuous marketing improvement.
We are especially excited about our partnership with Salesforce, which enables us to better leverage the unified view of our millions of customers and act on our robust customer data that has been collected for more than three decades.
We can track every omnichannel customer journey and interaction, connect every commerce channel, create more engaging personalized and targeted marketing and messaging using predictive intelligence and adjust marketing in real-time based on trends or customer actions.
The Salesforce relationship also creates a data foundation to support the rollout of our enhanced loyalty program in the second half of this year.
And our loyalty program already has some of the highest participation rates in retail at over 90%.
We also have some of the most loyal and long-tenured customers in retail.
Our Chico's customers averaged well over 12 years with us.
White House black market customers average nine and Soma customers average over six, demonstrating we have the ability to retain new customers for a very long period of time.
We will continue to elevate our marketing efforts with more digital storytelling, the use of social influencers and to build upon our organic social efforts and wider-by communication.
Number four, maintaining our operating and cost discipline.
We will continue to improve our sourcing, logistics and operational processes to drive efficiencies and speed and lower cost.
We have teams focusing on a wider range of areas from further diversifying the supply chain, lowering dependence on agents, increasing the use of 3D design, and streamlining outbound shipping and ship from store processes, just to name a few.
Over the last year, we have reduced our supplier base by 20%, and agents currently represent 32% of the business, and we expect to lower that to about 18% by 2022.
And finally, number five, further enhancing the productivity of our real estate portfolio.
Stores continue to be an important part of our omnichannel strategy, and digital sales are higher in markets where we have our retail presence.
Soma is certainly a great example of that.
While Soma is now a digital-first business, it is supported by 259 boutiques.
In alignment with driving Soma to be one of the largest intimate apparel brands in the country, we are excited about opening Soma shop-in-shops in a number of Chico's boutiques.
We have opened 10 so far this year, and we will open 40 more by early May.
Our marketing data indicates that Soma and Chico's in-store cross-shop opportunities are abundant.
And we believe the shop-in-shop format will deliver meaningful brand awareness and generate both store and digital sales in markets where we are underpenetrated.
In addition, we plan to convert eight White House black market locations into Soma Boutiques.
We will also continue rationalizing and tightening our real estate portfolio, reflecting our emphasis on digital and our priority or higher profitability standards.
We are currently driving store sales with less inventory and increased productivity.
We've closed 40 underperforming locations since the beginning of fiscal 2020 and ended the fiscal year with 1,302 boutiques.
We will continue to shrink our store base to align with these standards, primarily as leases come due, lease kick-outs are available or buyouts make economic sense.
We have strong lease flexibility with nearly 60% of our leases coming up for renewals or kick-outs available over the next three years.
To further improve store productivity, we anticipate closing 13% to 16% of our remaining store fleet over the next three years, with 40 to 45 of those closures occurring in fiscal 2021.
The vast majority are expected to be mall-based Chico's and White House black market stores.
This means from the beginning of fiscal 2019 through the end of fiscal 2023, we will close up to a total of 330 stores, well ahead of our original multiyear closure target of 250 stores.
Our balance sheet remains solid.
We ended the fiscal year with $109 million of cash and cash equivalents after paying $38 million in fourth-quarter rent settlements.
And we navigated the fourth quarter without increasing debt levels on our newly amended credit facility, which matures in October 2025.
As you recall, last year, we renegotiated over 90% of our store leases, resulting in commitments of $65 million in rent abatements and reductions.
On a cash basis, approximately $44 million of these savings were realized in fiscal 2020, with the majority of the balance expected to be realized in fiscal 2021.
This $65 million represented about 25% of our annual rent expense, which we felt was a reasonable request at the time.
However, with the effect of the pandemic now extending well beyond original expectations this month we are launching Phase 2 of our lease renegotiation process, going back to our landlords for additional reductions.
Phase 2 will focus on the continuing COVID impact on our stores.
We will again work with A&G Real Estate Partners to obtain what we expect will be meaningful rent concessions.
We will provide an update on this initiative during our first-quarter earnings call.
In the fourth quarter, we permanently closed eight stores, bringing our net year-to-date closures to 39.
As of fiscal year-end, we have closed 123 stores since the beginning of fiscal '19.
Turning to fourth-quarter performance.
Net sales totaled $386.2 million compared to $527.1 million last year.
This 26.7% decrease reflects a comparable sales decline of 24.9% as well as the impact of 39 net store closures in the year, partially offset by a double-digit growth in digital sales.
For the fourth quarter, we reported a net loss of $79.1 million or $0.68 per diluted share, which included $35.9 million or $0.32 per diluted share and significant after-tax noncash charges outlined in today's release.
The majority of these charges related to a $32.1 million or $0.28 per share deferred tax asset valuation allowance.
Gross margin in the fourth quarter was 19% of net sales compared to 32.5% last year.
The rate decline primarily reflected lower maintained margin in our apparel brands and deleverage of fixed occupancy cost.
Lower apparel maintained margin rates primarily reflected the impact of declines in average unit retails, with higher sales driving promotional activity and increased markdowns mix versus last year.
Also keep in mind that fourth-quarter occupancy cost, a component of gross margin, does not reflect the meaningful savings from rent reductions as these reductions are being recognized pro rata over remaining lease terms.
I'm pleased with how swiftly our team pivoted at our assortment and managed inventory.
We believe our inventory is current and properly balanced with the influx of new seasonally appropriate receipts.
We ended the year with inventories down over 17% from the prior fiscal year-end.
And weeks of supply are substantially less than last year.
More importantly, our inventory is appropriately targeted.
Our apparel inventories are down over 20%, and some inventories are up 2% year over year.
As we look ahead to the first half of fiscal '21, we are planning year-over-year apparel inventories down more than 30%, and Soma inventories up over 30% as we continue to cannibalize on the momentum in this rapidly growing business.
SG&A expenses for the fourth quarter totaled $136.2 million, an improvement of $40.8 million from last year, reflecting our ongoing expense reduction initiatives to align our cost structure with sales.
The effective fourth-quarter tax rate was a provision of 20.4% compared to a benefit of 21.6% from last year's fourth quarter.
The current year effective tax rate primarily reflects the deferred tax asset valuation allowance charge, partially offset by the favorable rate differential due to the benefits provided under the CARES Act.
The fourth-quarter valuation allowance is a noncash charge as a result of ongoing pandemic-related uncertainty, surrounding future realizability of the related deferred tax assets.
Our financial position liquidity are being bolstered by strong digital performance across all brands.
Retail store sales and a significantly leaner expense structure that better aligns cost with sales.
In addition, our fiscal year-end balance sheet reflects a federal income tax receivable of approximately $35 million that we expect to realize in the second quarter of fiscal '21.
Turning to our outlook.
However, we believe it would be helpful to have a view into our planning for the coming year and are providing color.
At this time, we expect to benefit from the COVID-19 vaccine rollout, particularly given our customer base and are planning for consolidated sales trends to improve in the back half of the year.
As Molly noted, we are seeing traffic trends in proven areas where vaccines are becoming more widely available.
For planning purposes, consolidated sales trends for the first half of the year are expected to be largely in line with our reported fiscal 2020 results.
Looking at each brand, we expect continued strong performance at Soma, with performance at Chico's and White House, consistent with market expectations.
In addition, we expect our ongoing investment in the digital channel to deliver continued sales growth.
We expect cost savings realized in fiscal 2020 to be maintained in fiscal '21.
We are continuing to implement supply chain efficiencies and intend to maintain stringent inventory controls, with fiscal 2021 first half inventories planned down roughly 30% to last year.
These actions are expected to deliver significant improvement in current margin levels.
We believe the actions we have taken, combined with our solid financial position, increased flexibility under our credit facility and our competitively positioned brands, enable us to emerge as a stronger company in 2021 and beyond.
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compname reports q4 loss per share $0.68.
q4 loss per share $0.68.
q4 sales $386.2 million versus $527.1 million.
fiscal year-end total inventories down over 17% and store inventories down 25%.
not providing specific fiscal 2021 first-quarter or full-year financial guidance at this time.
qtrly comparable sales was a decline of 24.9%.
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Before we begin, I'd like to review the Safe Harbor statements.
During the call today, we may also discuss non-GAAP financial measures.
Additionally, the content of this conference call may contain time sensitive information that is accurate only as of the date of this earnings call.
We do not undertake and specifically disclaim any obligation to update or revise this information.
I will now turn the conference over to our CEO and chief investment officer, Mohit Marria.
Joining me on the call today are Choudhary Yarlagadda, our president and chief operating officer; Rob Colligan, our chief financial officer; and Vic Falvo, our head of our capital markets.
This quarter we took many proactive steps toward portfolio optimization and the expansion of Chimera's core earnings.
Key drivers of our performance include recirculation of mortgage loans and the refinancing of credit at lower interest rates.
The housing market continues to be robust across America.
And though longer term interest rates have risen since year end, the interest rates available for residential mortgage remain very low by historical measures.
Home prices are increasing at their fastest pace since the first quarter of 2006 and on a year-over-year basis the S&P Case-Shiller index reported 11.2% increase in home price appreciation.
Strong housing demand coupled with a limited supply of homes available for sale provide strong tailwinds in housing finance.
Home price appreciation is an important metric when evaluating future mortgage credit performance.
Interest rate on 10-year U.S. Treasuries rose 83 basis points this quarter, while short term interest rates remain near zero.
The yield curve deepened over the period with a spread between two-year and 10-year treasury notes doubling to 158 basis points on market concerns of future inflation expectations.
Federal Reserve policy remained unchanged this quarter, and the Fed indicated it's believed that recent signs of inflation are expected to be short term in nature and are elevated due to pandemic related issues.
Credit spreads on fixed income products tightened as investors continue to seek higher yielding investments for their portfolios.
The BMO's high yield index ended the quarter tighter by 57 basis point while spreads AAA rated securitized reperforming loans tightened by an approximately 15 basis points.
The current market conditions have presented a unique opportunity to optimize Chimera's liability structure, locking in low cost financing for many quarters into the future.
As part of our call optimization strategy, this quarter we exercise our call rights on six outstanding deals representing $4.1 billion of residential mortgage loans.
In February, we issued $2.1 billion CIM 2021-R1 and $233 million CIM 2021-NR1.
The mortgage loans for both securitizations were from call and the termination of three CIM securitization previously issued in 2016.
These securitizations created $1.9 billion of new securitized debt at a weighted average cost of 2.04%.
The terminated debt had $1.7 billion outstanding with the previous cost of 5.2%, a savings of more than 300 basis points.
In March, we issued $1.5 billion CIM 2021-R2 and $240 million CIM 2021-NR2.
The mortgages for both securitizations from the call and termination of three CIM securitizations.
previously issued in 2017 and 2018.
The March securitizations created $1.5 billion of new securitized debt, at a weighted average cost of 2.24%.
The terminated debt had $1.2 billion outstanding, with a previous cost of 4.22%, a savings of about 200 basis points.
The high advance rate on these four securitizations enabled us to release equity, locked in from the prior securitizations and lower our costs of securitized debt by 265 basis points.
The retained tranches from those securitizations were financed with non mark-to-market repo.
We expect to see the full benefits of all four securitizations in the new quarter.
For the month of April we issued $860 million CIM 2021-R3 and $117 million CIM 2021-NR3.
The mortgages for both securitizations were from the call and termination of three CIM deals previously issued in 2017.
The April securitizations created $813 million of new debt at a weighted average cost of 2.12%.
The terminated debt had $682 million outstanding, with a previous cost of 4.14%.
a savings of 200 basis points.
The R3 and NR3 deals closed in late April.
Securitizations of assets is a critical component of Chimera's business model.
It provides low cost, long term non-recourse debt for mortgage assets on our balance sheet.
Securitized debt represents nearly 70% of Chimera's liabilities structure.
We expect all the new securitizations issued this year to provide durable portfolio income for many years to come.
At the end of March, Chimera paid off $4 million, 7% secured financing, and retired for cash the associated warrants on approximately 20 million shares.
The cash cost on the warrants came at a 10% discount to the value of our common stock and then eliminated any future equity dilution on these shares.
The equity recaptured from our first quarter of securitizations enabled us to terminate this debt early and rebalance our liability structure.
Our secured financing now stand at $4 billion down for $4.6 billion at quarter end.
The weighted average rate on our secured financing at the end of March was 2.7%, down 70 basis points from 3.4% at year end.
The optimization of our securitized debt combined with a continued improvement in our secured financing positions Chimera's portfolio to reap long term benefits, while maintaining little recourse leverage.
On the asset side of the balance sheet, this quarter Chimera purchase and securitized NR CIM 2021 J1 and J2 deals, a total of $884 million prime jumbo loans.
Separately, through a series of transactions, we purchased $166 million high yielding business purpose loans.
The weighted average coupon on these loans was 8.5% and has an expected portfolio yield of 7%.
These loans are short duration and are currently being financed in our loan warehouse.
Our agency CMBS portfolio continues to perform well as expected, as increased rate volatility during the quarter we proactively managed to our agency CMBS portfolio.
This quarter we sold $182 million Ginnie Mae project loans, generating $14 million in realized gains.
In addition, seven Ginnie Mae project loans were called during the quarter totaling $146 million.
Unlike traditional agency pass-throughs, Ginnie Mae project loans carry explicit call protection, and due to this feature we collected approximately $14 million in interest income through P-pay penalties.
As we look forward into the second quarter, the housing market remains strong and provides added benefit for improved credit performance.
Chimera's portfolio with seasoned low loan balance loans continue to generate solid top-line performance, while demonstrating little sensitivity to prepayments.
Through the end of April, we have re securitized $5.1 billion loans, lowered our cost of financing and freed up capital to help pay down higher cost debt.
And over the remainder of 2021, we have eight additional deals with approximately $1.7 billion unpaid balance for potential resecuritizations.
Chimera's portfolio is currently structured to offer shareholders an attractive dividend relative to our low recourse leverage.
As we near the post pandemic world, Chimera is well positioned to grow our portfolio with additional income opportunity.
I'll review Chimera's financial highlights for the first quarter of 2021.
GAAP book value at the end of the first quarter was $11.44.
GAAP net income for the first quarter was $139 million or $0.54 per share.
On a core basis.
net income for the first quarter was $87 million or $0.36 per share.
Economic net interest income for the first quarter was $136 million.
For the first quarter, the yield on average interest earning assets was 6.4%.
Our average cost of funds was 3.3%.
And our net interest spread was 3.1%.
Total leverage for the first quarter was 3.6:1, while recourse leverage ended the quarter at 1.1:1.
For the quarter, our economic net interest return on equity was 15%.
And our GAAP return on average equity was 17%.
Expenses for the first quarter, excluding servicing fees and transaction expenses were $18.6 million, up slightly from last quarter.
That concludes our remarks.
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compname reports q1 earnings per share of $0.54.
q1 gaap earnings per share $0.54.
q1 core earnings per share $0.36.
qtrly book value of $11.44 per common share.
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Before we begin, I'd like to review the safe harbor statement.
During the call today, we may also discuss non-GAAP financial measures.
Additionally, the content of this conference call may contain time-sensitive information that is accurate only as of the date of this earnings call.
We do not undertake and specifically disclaim any obligation to update or revise this information.
I will now turn the conference over to our president and chief executive officer, Matthew Lambiase.
I'll make some brief comments, then Mohit will discuss the changes in the portfolio and Rob will then review our financial results.
I believe the first six months of 2020 will go down in the financial history books as one of the most volatile periods in modern times.
The U.S. economy went from excellent to dismal in the span of just a few months and the financial markets, especially fixed income, experienced record volatility and record intervention from the government.
In our space, many levered investors were caught off guard by the swiftly falling asset price, and they were forced to sell at the low point of the market.
Fortunately, Chimera was able to navigate through this difficult period by executing transactions which enabled us to retain our high-yielding and unique mortgage credit portfolio.
It's important to understand that it will be very difficult, if not impossible, to recreate our portfolio in the current low interest rate environment and its retention affords Chimera the ability to pay a meaningful dividend, which we would not have if the assets had been sold.
In the quarter, we took several actions that helped us augment our liquidity.
We issued a $374 million three-year convertible bond, we entered into a $400 million three-year revolving loan facility arranged by Ares Capital and we executed three new mortgage securitizations, totaling over $1 billion, which significantly reduced our loan warehouse exposure and helped reopen the mortgage securitization market, which is a primary source for Chimera's long-term financing.
Additionally, during the period, we negotiated longer-term and non-mark-to -- longer-term and non-mark-to-market repo finance facilities for our mortgage loans and credit-related assets.
We now have approximately 75% of our credit borrowings on longer-term facilities and over 50% of them have no mark-to-market or limited mark-to-market arrangements.
While these actions have had the short-term effect of increasing financing costs, we believe the benefits over the long-term are significant.
We've strengthened our balance sheet, enabling us to further withstand additional market volatility, continue to produce attractive spread income and to make new investments when we see attractive asset opportunities.
This position is enviable, given the uncertain economic conditions and the low return environment that we're currently operating within.
The Federal Reserve has stated that they expect to keep the Fed funds rate zero bound for the next two years and that they will continue to buy large quantities of assets to support the financial markets and the U.S. economy.
We are present -- presently witnessing the effects of these actions.
The 10-year treasury yield is now roughly 55 basis points and a rate on a new 30-year mortgage dipped below 3% for the first time in history.
Current market expectations are that we'll be in this low rate environment for several years to come, and that the returns on all financial assets will be also low into the future.
While the Federal Reserve's asset purchases have not been directly focused on residential mortgage credit, their purchases have started solidifying the markets and senior mortgage bonds have witnessed significant price appreciation.
We would expect that over time, deeper credit subordinate residential bonds could see similar moves.
Chimera's portfolio of higher-yielding legacy assets should become ever more valuable as the Fed continues to buy assets and returns in the market become ever more scarce.
Residential mortgage credit, due to the size of the market and the slow recovery of pricing, offered some of the best opportunities in the fixed income market.
The economics for loan securitization continues to be attractive as the credit curve remains steep.
Senior front-end bonds are well bid, creating an opportunity to securitize loans and retain higher-yielding, back-end subordinate investments.
These subordinated bonds have high relative yield and the potential for meaningful appreciation should markets normalize.
We have executed three securitizations in the period and retained the subordinate tranches from those deals.
Looking forward, we believe that there will be ample supply of loans for sale from the GSEs and banks, and this supply will create opportunities for us to make new investments for our portfolio.
Given the current low yield and low return environment, we think being able to create investments through securitization will allow us to continue to produce attractive results in this challenging market.
While this has been a very difficult period to navigate through, we believe Chimera is well-positioned for the future.
We have materially reduced our exposure to mark-to-market risk on our repo financings, which should help us manage through bouts of volatility in the future.
We have been able to retain our legacy portfolio of assets, which will allow us to continue to produce meaningful dividends for our investors in what may be an extended period of low interest rates.
The retained portfolio also has the potential for book value appreciation if pricing returns to historical levels.
And finally, we believe there are attractive opportunities currently available in the residential loan market and we have a team and a history of being able to use securitization to successfully create high-yielding investments for our portfolio.
As a result of unprecedented monetary and fiscal support provided by the government, the second quarter saw a material improvement in both the equity and fixed income markets.
Parts of the equity markets are flat to up year-to-date while treasury rates were stable in Q2.
With rates stable and the Fed rhetoric for a lower rate for the foreseeable future, volatility has subsided.
The crowding out effect created by the Fed's market intervention has been positive for all highly rated fixed income securities.
The Federal Reserve was mostly focused on agency securities and did not purchase residential mortgage credit.
The shortage of legacy credit assets available, after a slow start in April, new issue securitization volumes were brisk in the second quarter.
Senior tranches of securitized residential product improved steadily with the strongest performance in the latter half of the second quarter.
During the quarter, we focused on the liability side of our balance sheet and entered into three non-mark-to-market facilities to finance $2 billion of our non-agency portfolio.
In addition, we have limited mark-to-market on $611 million of non-agency securities.
As a result of these transactions, approximately 54% of our non-agency borrowings are not subject to full mark-to-market risk.
As of quarter end, the weighted average term to maturity has increased to 698 days from 223 days in the first quarter.
To reduce the risk on our warehouse lines, we completed three securitizations, totaling approximately $1.1 billion in seasoned, reperforming mortgage loans.
Moving loans from warehouse to securitization is an important aspect of our portfolio strategy as it reduces the mark-to-market risk and improves risk metrics for the company.
After the completion of this quarter's securitization, our residential mortgage loan warehouse stands at $263 million and is financed for one year without mark-to-market risk.
CIM 2020-R3 issued in May had $438 million underlying loans with a weighted average coupon of 5.28% and a weighted average loan age of 150 months.
The average loan size in the R3 securitization was $127,000 and the average FICO was 651 with an average LTV of 80%.
We sold $329 million senior securities with a 4.2% cost of debt.
Chimera retained a May 2022 calendar call option for the R3 securitization.
CIM 2020-R4 had $276 million underlying loans, with a weighted average coupon of 4.78% with a weighted average loan age of 168 months.
The average loan size in the R4 was $127,000.
The average FICO was 598 with an average LTV of 75%.
We sold $207 million senior securities with a 3.2% cost of debt.
Chimera retained a June 2022 calendar call option on the R4 securitization.
In early July, Chimera completed a second rate of securitization of the year.
We issued CIM 2020-R5 with $338 million underlying loans with an average coupon of 4.98%.
The R5 securitization had a weighted average loan age of 149 months and an average loan size of $152,000.
The loans had a weighted average FICO of 678 with an average LTV of 70%.
We sold $257 million of investment-grade securities with a 2.05% cost of debt, more than 200 basis points tighter than our early May deal.
And in late July, we issued $362 million CIM 2020-J1, our first jumbo securitization of the year.
Overall, we are pleased with the current investment portfolio and its long-term prospects.
We were able to navigate through this difficult period by executing transactions, which enables us to retain our high-yielding and unique mortgage credit portfolio.
Strong credit performance, strength of institutional buying, and the tightening of new issue credit spreads were all positive components of Chimera's long-term securitization strategy.
We have 13 existing CIM securitization totaling $7.5 billion available for call and refinancing over the next 12 months.
This provides an additional avenue for portfolio performance and complements potential new investment opportunities.
We are continually monitoring our outstanding securitization for the best timing and the opportunity to execute our call optimization strategy and maximize long-term portfolio performance for our shareholders.
Our Agency CMBS continue to provide attractive spread income and liquidity for the portfolio while providing superior call protection relative to residential agency pass-throughs in this low rate environment.
Lastly, the reduction in mark-to-market achieved this quarter leaves us with plenty of dry powder to make new credit investments.
I'll review Chimera's financial highlights for the second quarter.
GAAP book value at the end of the second quarter was $10.63 per share.
Our GAAP net loss for the second quarter was $73 million or $0.37 per share.
On a core basis, net income for the second quarter was $76 million or $0.32 per share.
Our economic net interest income for the second quarter was $121 million.
For the second quarter, our yield on interest-earning assets was 5.7%, our average cost of funds was 3.3%, and our net interest spread was 2.4%.
Total leverage for the second quarter was 4.3:1 while recourse leverage ended the quarter at 1.8:1.
Expenses for the second quarter, excluding servicing fees and transaction expenses were $17 million, down from last quarter, primarily related to lower compensation expenses.
We currently have approximately $850 million in cash and unencumbered assets.
This is after we've paid both our preferred and common dividends in full.
We continue to monitor liquidity closely and look for attractive financing options to support our portfolio.
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chimera investment q2 core earnings per share $0.32.
q2 core earnings per share $0.32.
q2 gaap loss per share $0.37.
qtrly gaap book value of $10.63 per common share.
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Before we begin, I'd like to review the safe harbor statements.
During the call today, we may also discuss non-GAAP financial measures.
Additionally, the content of this conference call may contain time-sensitive information that is accurate only as of the date of this earnings call.
We do not undertake and specifically disclaim any obligation to update or revise this information.
I will now turn the conference over to our CEO and chief investment officer, Mohit Marria.
Joining me on the call today are Choudhary Yarlagadda, our president and chief operating officer; Subra Viswanathan, our new chief financial officer; Kelley Kortman, our chief accounting officer; and Vic Falvo, our head of capital markets.
This quarter, we continued to make significant progress toward optimization of our liability structure.
For the six months of 2021, we successfully refinanced 12 legacy CIM securitizations supporting more than $5.6 billion of loans.
The results of these transactions has lowered our overall cost of debt by approximately 245 basis points, and we expect this cost savings to continue to benefit our shareholders in the future.
The National Association of REALTORS recently reported sales of existing homes at 5.9 million annual units, with a median sale price of more than $363,000, up more than 23% from a year ago.
Demand for single-family homes remain strong, while the inventory of homes available for sales persist near record low levels.
According to Black Knight data and analytics, in June, the national delinquency rate hit its lowest level since the onset of the pandemic and is now back below the pre-great recession average.
The 30-plus day delinquency rate was reported at 4.4% of outstanding loans, down 42% on a year-over-year basis.
Strong demand for existing homes, higher home prices, and lower delinquency rates provide strong fundamental support for Chimera's large portfolio of seasoned low-loan balance mortgages.
Interest rates on government bonds experienced a both flattening move in the second quarter.
Over the period, the yield on 10-year treasury notes fell by 27 basis points while the yield on two-year treasury rose by nine basis points.
Interest rates on money market instruments, including overnight repo remained near zero.
Investor demand for higher-yielding fixed income products were strong and spreads on credit products continue to trend tighter.
Accordingly, the Bloomberg Barclays U.S. Corporate High Yield Index ended the quarter at 3.75%, its lowest yield ever.
Tighter credit spreads, coupled with low-absolute interest rates, have presented attractive market opportunities to refinance our existing securitized debt and secured financing at significantly lower costs.
As part of our continued call optimization strategy, this quarter, we called and refinanced six CIM legacy deals, representing more than 1.5 billion of loans.
The new securitization successfully optimized our liabilities through the extraction of capital and lowering cost of debt.
Our April deals, CIM 2021-R3 and NR3 on a combined basis, had a total of 813 million of securitized debt supported by 977 million of loans.
The combined advance rate was 83%, enabling us to extract 125 million of capital while lowering our cost of debt for these loans by 200 basis points to 2.12%.
Chimera retained 164 million of subordinate and IO securities as investments from these deals.
The new securitizations have a calendar call dates.
The R3 financing will be callable beginning April 2024 and the NR3 financing is callable beginning April of 2022.
In June, we issued 546 million CIM 2021-R4.
The deal consisted of 464 million securitized debt, representing an 85% advance rate and a 1.97% cost of debt for these loans.
The R4 freed up 98 million of capital and provided cost savings of approximately 180 basis points.
Chimera retained 82 million of subordinate and IO securities as investments.
The R4 financing has a calendar call date beginning June 2024.
We have provided additional details on Page 8 of our earnings supplement to further assist you in the analysis of this quarter's CIM securitizations.
Securitizations has long been a cost-effective and efficient financing vehicle for Chimera.
In the first half of 2021, Chimera's resecuritization activity enabled us to take out capital, reduce the size, and lower the cost of our outstanding credit financing.
And in conjunction with this year's resecuritizations, we have also refinanced several of our outstanding secured credit facilities.
We have made meaningful improvements with the average cost of our secured financing for residential credit assets in the second quarter at 3.5%, down from 4.9% at year end.
We've always been extremely prudent and diligent when making our long-term investment decisions.
Our Agency CMBS portfolio is constructive with explicit prepay protection.
As interest rates have fallen and maintained near historic lows, we have been active in managing our Agency CMBS to determine the best course of action between long-term hold and gain on sale securitization or reaping benefits through explicit prepay penalties.
This quarter, through the combination of prepay penalties received from our Ginnie Mae project loans and early pay downs of non-agency credit, we generated onetime nonrecurring income of 38 million.
Our prepay penalties we received this year is proof of concept for many of the positive convexity attributes we have regularly discussed over the years.
Now at the midpoint of 2021, I believe we have made a meaningful impact on our balance sheet.
We have resecuritized debt supporting 5.6 billion of loans through seven separate securitizations, lowered our cost of securitized debt by over 245 basis points, lowered the cost of our repo credit facilities by 140 basis points since year end, retired high-cost debt and warrants incurred during the pandemic, issued three jumbo prime securitizations totaling 1.2 billion, purchased more than 200 million of high-yielding fix and flip loans and increased our quarterly dividend by 10% to $0.33.
Securitizations of loans locking stable long-term financing for our loan portfolio.
We have successfully refinanced many of our outstanding legacy deals, and we have an additional five deals with 1 billion of unpaid principal balance that are or will become callable over the next six months.
Looking forward, we continue to seek opportunities to further improve our liability structure.
And as always, stay the course as a patient long-term investor focus on investments to provide our shareholders with stable book value and a sustainable and attractive risk-adjusted dividend.
I'll now review Chimera's financial highlights for the second quarter of 2021.
GAAP book value at the end of the second quarter was $11.45 per common share.
GAAP net income for the second quarter was 145 million or $0.60 per share on a fully diluted basis.
Our core earnings for the second quarter was 130 million or $0.54 per share.
Economic net-interest income for the second quarter was 173 million.
The yield on average interest-earning assets was 7% for the second quarter, while our average cost of funds was 2.6%, resulting in a net-interest rate spread of 4.4%.
Total leverage for the second quarter was 3.3 to one, while our recourse leverage ended the quarter at 1.0 to one.
For the quarter, our economic net-interest return on equity was 19%, and our GAAP return on average equity was 18%.
Expenses for the second quarter, excluding servicing fees and transaction expenses, were 15 million, down approximately 3 million from last quarter.
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q2 gaap earnings per share $0.60.
q2 core earnings per share $0.54.
quarter-end gaap book value of $11.45 per common share.
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Before we begin, I'd like to review the safe harbor statement.
During the call today, we may also discuss non-GAAP financial measures.
Additionally, the content of this conference call may contain time-sensitive information that is accurate only as of the date of this earnings call.
We do not undertake and specifically disclaim any obligation to update or revise this information.
I will now turn the conference over to our president and chief executive officer, Matthew Lambiase.
I'll make some brief comments, then Mohit will discuss the changes in the portfolio, and Rob will review our financial results.
Chimera continues to work remotely, and I'm happy to report that the team is safe and our remote work environments have been successful.
Over the past six months, we've taken many steps to strengthen our balance sheet, protect our desirable credit assets, and stabilize the earnings stream of our portfolio.
These steps included selling agency mortgage-backed securities, selectively selling agency CMBS, negotiating new non-mark-to-market financing arrangements, and lowering the company's overall recourse leverage.
The actions taken over the period enabled us to participate in the market recovery of asset prices from the depressed levels that we experienced in March.
For the quarter, Chimera's book value appreciated 12% to $11.91 per share.
We generated $0.33 of core earnings, and we paid $0.30 in common dividend, resulting in nearly 15% economic return for the period.
The rebound in residential mortgage prices this quarter can be attributed to a very strong housing market, which has been boosted by a generational lull in U.S. interest rates.
The COVID-19 pandemic has had a dramatic effect on the housing in the United States.
The market for single-family homes is thriving as many families are fleeing cities for more spacious quarters in the suburban and rural areas of the country.
Families across America are seeking additional living space for home offices, home classrooms, and safe outdoor environments.
labor force is currently working full time from home.
Demand for single-family homes is booming.
The rate of existing-home sales rose in September to 6.5 million homes, the highest level since 2006.
And the available inventory of existing home sales has decreased nearly 20% from the previous year to 1.5 million homes.
At the current pace of home sales, all-in inventory currently on the market could be sold in less than three months.
Much of this housing demand is driven by record-low borrowing rates orchestrated by the Federal Reserve.
Since March, the Federal Reserve has increased its balance sheet by 75% to over $7 trillion, helping to provide low interest rates and ample liquidity to the mortgage market.
The average rate for 30-year mortgages was recently reported at 2.8%, the lowest rate on record, which dates back to 1971.
Additionally, fiscal stimulus from the federal government for COVID-19 relief has added over $3 trillion into the economy and has helped many mortgage borrowers through this difficult economic period.
Both political parties in Washington are currently discussing additional fiscal stimulus packages, which, if enacted, we believe, will help continue to support troubled borrowers and be constructive for both the housing and the mortgage market.
A robust housing market, paired with low mortgage rates and the government support, provide a very strong pace for owning residential mortgage credit.
As of quarter-end, nearly 90% of Chimera's investment portfolio was allocated to mortgage credit.
The mortgage securitization market has also returned to near pre-pandemic level and in some cases better as a result of lower interest rates and comparable advance rates.
This quarter, Chimera completed three securitizations while committing to purchase $640 million of mortgage loans.
Due to the improving housing fundamentals and better credit conditions, investor demand for highly rated senior mortgage securities is very strong.
Chimera is a frequent issuer of these securities, which enables us to secure long-term, non-mark-to-market financing for our credit portfolio assets.
Our investment team continues to find opportunities and is successful adding to our portfolio for future securitizations.
The housing market is one of the few bright spots in the U.S. economy, and higher housing prices can contribute to better mortgage credit fundamentals.
In a world of low investment returns, having a high-yielding portfolio with a favorable credit profile is an enviable position to be in.
We believe that Chimera's portfolio is well-positioned to take advantage of these positive trends and to continue to produce strong dividend income for our shareholders in the quarters ahead.
The 10-year treasury ended the quarter with a yield of 68 basis points, down from 1.92% at the start of 2020.
The overall magnitude of this rate movement has generated price appreciation in 10-year treasury notes of approximately 10 points since the beginning of the year.
Our agency CMBS investments over the last five years have primarily been Ginnie Mae project loans.
These securities carry government guarantees, and due to explicit prepayment lockout and penalties, the Ginnie Mae permanent loan certificates are longer-duration assets.
The price performance of these assets has greatly benefited as treasury rates have fallen.
During the third quarter, we acted on the strong price performance and selectively sold $659 million securities from our agency CMBS portfolio.
With the sale, we harvested approximately $65 million in gain and plan to reallocate capital into mortgage credit.
The objective of the reallocation is long-term optimization of the portfolio income for the benefit of our shareholders.
We continue to monitor our agency CMBS holdings relative to their market values and their explicit call protection to maintain a right-sized and optimal portfolio of our agency CMBS.
Our remaining agency CMBS holdings at quarter-end was $1.8 billion, comprising 10% of Chimera's total investment portfolio.
The new issue market for securitized products remained strong in the third quarter, and spreads on certain parts of the capital structure have approached pre-COVID-19 levels.
Tighter spreads and low absolute interest rates create compelling opportunities for frequent and well-recognized issuers like Chimera to meet investor demand for securities.
For the third quarter, Chimera closed three securitized transactions totaling a little over $1 billion.
The senior note from all three deals carried investment-grade ratings.
In July, we issued CIM 2020-R5 with $338 million loans from our existing loan warehouse.
The underlying loans in the deal had a weighted average coupon of 4.98% and a weighted average loan age of 149 months.
The average loan size in the R5 transaction was $152,000 and had an average LTV of 70%.
The average FICO score for the borrowers was 678.
We sold $257 million senior securities from this deal and retained $81 million in subordinated notes and interest-only securities.
Our cost of investment-grade debt for CIM 2020-R5 was 2.05% with a 76% advance rate.
Separately, in two transactions, we securitized pools of prime jumbo mortgage loans and a pool of agency-eligible investor mortgage loans.
CIM 2020-J1 was our first prime jumbo securitization for 2020.
The deal had $362 million loans with a weighted average coupon of 3.76% and a weighted average loan age of six months.
The average loan size was $732,000 and had an average FICO of 766 and an average LTV of 67%.
CIM 2020-INV1 was our first agency-eligible investor loan securitization for 2020.
This deal size was $335 million with a weighted average coupon of 4.31%.
It had an average loan size of $332,000.
The loans had an average FICO of 765 with an average LTV of 64%.
The J1 and the INV1 securitizations are not consolidated on our balance sheet.
We invested $22 million in these transactions for our non-agency RMBS portfolio.
During the third quarter, we committed to purchasing over $400 million of seasoned reperforming loans.
And post quarter-end, we securitized the loans into CIM 2020-R6.
Strong investor demand for senior notes enabled us to move quickly from purchase to securitization.
The deal priced on October 30 and is expected to close in early November.
We will report the details of this transaction on our fourth-quarter 2020 earnings call.
We continue to invest in residential business purpose loans.
These loans, commonly referred to as fix and flip, provide an attractive, high-yielding, short-duration assets for our portfolio.
The market for these loans continues to expand and is well supported by a positive housing market and repeat business purpose borrowers.
For the year, we successfully purchased approximately $135 million in business purpose loans and ended the quarter with approximately $210 million on the balance sheet.
The average coupon on this portfolio was 8.57% with a weighted average LTV of 80%.
Our investment portfolio is well-positioned as we approach year-end.
The market trends in single-family housing are positive, and the securitization market is strong.
At quarter-end, we had $412 million loans on our mortgage warehouse for potential future securitizations and have ample liquidity to and opportunistically acquire new pools of loans.
On the liabilities side of our balance sheet, we have taken steps this year to lower the impact of mark-to-market risk on our secured financing.
Recourse leverage is materially lower on the year and currently stands at 1.3 times capital.
We have ample liquidity to make new investments.
And as part of our call optimization strategy, we actively monitor our outstanding securitizations for optimizing our long-term debt structures.
And as of September 30, Chimera has $5.8 billion of outstanding securitized debt in 16 separate deals that is either currently callable or will be callable through the end of 2021.
I'll review Chimera's financial highlights for the third quarter.
GAAP book value at the end of the third quarter was $11.91.
And GAAP net income for the third quarter was $349 million or $1.32 per share.
On a core basis, net income for the third quarter was $80 million or $0.33 per share.
Economic net interest income for the third quarter was $125 million.
For the third quarter, the yield on average interest-earning assets was 6%.
Our average cost of funds was 3.5%, and our net interest spread was 2.5%.
Total leverage for the third quarter was 3.7 to 1, while recourse leverage ended the quarter at 1.3 to 1.
Expenses for the third quarter, excluding servicing fees and transaction expenses, were $17 million, in line with last quarter.
We continue to closely monitor liquidity and have approximately $1 billion in cash and unencumbered assets as we look for new investments and financing options to support our portfolio and to optimize investment returns.
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chimera investment q3 core earnings per share $0.33.
q3 core earnings per share $0.33.
q3 gaap earnings per share $1.32.
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I'm joined today by Scott Buckhout, CIRCOR's president and CEO; and Abhi Khandelwal, the company's chief financial officer.
These expectations are subject to known and unknown risks, uncertainties and other factors and actual results could differ materially from those anticipated or implied by today's remarks.
You can find a full discussion of these factors in CIRCOR's Form 10-K, 10-Qs and other SEC filings also located on our website.
CIRCOR delivered solid first-quarter results as our portfolio of mission-critical products continues to perform.
While our end markets are not fully back to pre-pandemic levels, strong orders performance in the quarter gives us the confidence to raise our 2021 earnings guidance.
Starting with some financial highlights on Slide 2.
We booked orders of $227 million in the quarter, which were up 34% sequentially and 7% versus prior year on an organic basis.
We saw strong sequential increases in demand in both businesses, with industrial up 25% and A&D up 55%.
We ended the quarter with $421 million of backlog, up 11% versus prior quarter.
Revenue in the quarter was $181 million, down 8% organically, driven by lower industrial backlog entering 2021, the timing of large defense order shipments and slowly recovering demand in commercial aerospace.
Adjusted operating income was $12 million, representing a margin of 6.9%, up 110 basis points from prior year.
We expect strong margin expansion as we progress through 2021, driven by higher volume in virtually all regions and end markets, our continued actions on pricing, ongoing simplification across the company, and productivity.
The company delivered $0.24 of adjusted earnings per share and generated free cash flow of negative $21 million, both in line with our expectations.
Our cash performance in the quarter is consistent with typical seasonality due to the concentration of annual disbursements in the first quarter.
Starting with industrial on Slide 3.
Industrial organic orders were up 11% versus last year and 25% sequentially.
We're seeing recovery in virtually all of our end markets.
Regionally, we saw particular strength in EMEA, China and rest of Asia.
Notably, we booked two large international downstream orders in the quarter, which we will deliver over the next 12 months.
We delivered a strong book-to-bill ratio of 1.3 in the quarter.
Industrial revenue was $121 million, down 6% versus last year and 9% from prior quarter.
The year-over-year decline was a result of starting the year with a lower backlog and some COVID-related customer issues.
The sequential decline was largely driven by normal seasonality.
Adjusted operating margin was 8.1%, an improvement of 380 basis points versus last year.
The margin improvement was driven by the non-repeat of the COVID-related write-off from Q1 2020, partially offset by lower sales volume.
Adjusting for the impact of this receivable write off, organic decrementals in the quarter were 32%.
We expect industrial margins to expand through the year as volume increases and our price and productivity initiatives cut in.
Turning to Slide 4.
Our aerospace and defense segment booked orders of $73 million in the quarter, flat versus last year and up 55% sequentially.
Versus prior year, favorable defense orders offset the ongoing COVID-19 impact on our commercial business.
The sequential improvement was driven by the timing of large defense program orders for the Joint Strike Fighter, as well as the CVN-80 and 81 aircraft carriers.
Revenue in the quarter was $60 million, down 10% year over year and 23% from prior quarter.
Versus prior year, sales were down due to lower commercial revenue.
Sequential sales were lower due to seasonality and the timing of defense shipments for the Joint Strike Fighter, Dreadnought submarines and F-16 spares.
Orders and revenue in our defense business will continue to be lumpy, but we have a strong backlog, and we are well-positioned on growing platforms.
We're excited about the growth trajectory of the business.
Finally, operating margin was 18% in the quarter, down 130 basis points year over year.
The margin decline was driven by lower sales volume and unfavorable mix.
Organic decremental margins in the quarter were 29%.
We remain confident in our ability to expand operating margins throughout the year with higher volume, ongoing price actions and productivity.
Turning to Slide 5.
Our free cash flow was negative $21 million in the quarter.
As Scott mentioned, this was in line with the typical seasonality of our cash flow and timing of annual disbursements.
While capex was relatively flat, our cash flow from operations improved versus prior year as a result of our exit from upstream oil and gas.
We ended the quarter with $461 million of net debt, up slightly, driven by our cash flow in the quarter.
In 2021, we will continue to use free cash flow generated from operations to further pay down debt.
We expect to improve net debt to adjusted EBITDA leverage by greater than one turn by end of the year.
Now I'd like to share our expectations for second quarter and update our outlook for the full year.
In the second quarter, we expect revenue to be down 2% to 4% organically.
Scott will cover this in more detail in the upcoming slides, but let me provide the key highlights.
While we are seeing industrial demand recover across virtually all of our end markets, we expect deliveries to be heavily weighted to Q3 and Q4.
Similarly, in aerospace and defense, we expect a large portion of our recent orders in backlog to ship in the second half of the year.
Commercial aerospace will continue to recover slowly, as aircraft production rates and fleet utilization improves throughout the year.
We're expecting adjusted earnings per share of $0.30 to $0.35 in the second quarter, which implies approximately 75% of our full-year earnings that are expected in the second half.
This earnings profile was directionally in line with last year and was driven by the natural seasonality in our businesses.
Markets recovering from COVID-19 through the year and project shipment timing in aerospace and defense and industrial.
Finally, 2Q free cash flow is expected to be breakeven to slightly negative, driven by the timing of milestone payments on large projects.
Based on our first-quarter performance and expectations for second quarter, we have high confidence in delivering our 2021 commitments.
We now expect organic revenue growth at the high end of our original guidance and higher adjusted earnings per share of $2.10 to $2.30.
The increase is mostly driven by industrial, which is now expected to grow low to mid-single digits and increase confidence in our aerospace and defense outlook.
Free cash flow generation remains a top priority.
And we still expect to convert 85% to 95% of adjusted net income into free cash flow for the year.
Now I'll hand it back to Scott.
Let's start with our industrial outlook on Slide 7.
As Abhi mentioned, we saw recovery in the first quarter across virtually all industrial end markets with orders back to pre-COVID levels.
Geographically, we saw sequential improvement in North America and EMEA, while orders growth in China, India and rest of Asia remains strong.
We saw strong sequential and year-over-year orders growth in our short-cycle end markets.
In addition, we saw strength in our long-cycle businesses, with activity increasing overall and several large project orders across the portfolio.
So far in Q2, we continue to see momentum in our end markets with quoting activities at high levels and strong orders so far in the quarter.
For Q2 industrial revenue, we expect a moderate improvement year over year, with growth ranging between 1% and 4%.
We continue to see improvement across our short-cycle end markets as consumer demand increases.
In addition, the aftermarket remains strong with a mid-single-digit increase expected in the second quarter.
Our longer cycle end markets, including downstream, commercial marine and midstream oil and gas, are showing positive momentum, and we're encouraged by our deal pipeline and quoting activity.
Finally, pricing is expected to be a benefit of roughly 1%, consistent with prior quarters.
Moving to aerospace and defense.
Orders in Q1 were up sequentially and flat versus prior year, driven by timing of large defense program orders, which are inherently lumpy.
For the aftermarket, we expect improvements in defense spares and MRO activity through the year.
In our commercial aerospace business, we saw a modest improvement sequentially and expect a slow recovery to continue.
Revenue in the second quarter is expected to be flat to down 5% versus prior year.
Defense revenue is expected to be up 0% to 5% with strong volume on our top OEM programs.
Revenue from our other OEM programs and defense spares is expected to be relatively flat in the quarter.
Based on customer orders and timing of requirements, we expect stronger shipments in all major defense categories in the second half of the year.
Commercial revenue is expected to be down between 10% and 15%.
Our market position with Boeing and Airbus remains strong, and we expect revenue to improve through the year, in line with aircraft production rates and fleet utilization.
Finally, pricing is expected to be a benefit of 3% in the quarter with additional price increases coming in the second half.
We expect full-year pricing to be in line with last year.
Before we get into Q&A, I'd like to close by providing an update on the strategic priorities that I've shared for 2021, investing in people, accelerating growth, expanding margins and allocating capital effectively.
These strategic priorities guide what our team works on every day, and I wanted to take a moment to highlight some actions we've taken in the first quarter.
We remain focused on investing in growth.
Air Force T-X trainer jet and a high-speed impact kinetic switch module for a next-generation missile system for the U.S. Navy.
On the industrial side, we launched the CIRCORSmart app, our first mobile application and the start of a significant digital solution offering for our customers.
The mobile app allows a customer to scan a QR code affixed to the product, pull up performance data, user guides and contact information for technical support and aftermarket orders.
Over time, we'll add more capabilities to the app.
We expect more than 50% of industrial's product shipments to have a QR code attached by the end of the second quarter.
This enhances the customer experience and provides an opportunity for incremental high-margin aftermarket growth.
We're expecting to launch 45 new products in 2021, with revenue generated from new products launched in the last three years accounting for approximately 10% of our total 2021 revenue.
We're also expanding our aftermarket presence in aerospace and defense.
We're in the process of opening a Waterfront Service Center in Virginia.
This will improve customer support and increase our operational efficiency.
Finally, the CIRCOR operating system is driving operational improvements across the company.
For example, I recently visited one of our aerospace and defense sites, which produces components for the Joint Strike Fighter.
By implementing the CIRCOR operating system, the team has improved on-time delivery to 95%, improved product quality and cost and significantly lowered working capital as a percentage of sales.
Over the last three years, the business has grown 55% and expanded operating margins by 670 basis points.
This is just one example of the power of the CIRCOR operating system and our efforts to enhance operations.
Continued execution on our strategic priorities will deliver long-term value to our customers, employees, suppliers and shareholders.
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compname reports q1 loss per share of $0.35.
q1 adjusted earnings per share $0.24.
q1 gaap loss per share $0.35.
q1 revenue $181 million versus refinitiv ibes estimate of $187.9 million.
sees q2 adjusted earnings per share $0.30 to $0.35.
sees fy adjusted earnings per share $2.10 to $2.30.
expects q2 reported revenue to increase from 0%-2% and q2 organic revenue to decline 2%-4%.
now expects 2021 organic revenue growth in range of 2 to 4%.
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I'm joined today by Scott Buckhout, CIRCOR's president and CEO; and Abhi Khandelwal, the company's chief financial officer.
These expectations are subject to known and unknown risks, uncertainties and other factors and actual results could differ materially from those anticipated or implied by today's remarks.
You can find a full discussion of these factors in CIRCOR's Form 10-K, 10-Qs and other SEC filings also located on our website.
CIRCOR delivered another solid quarter, and we're entering the back half of the year with high confidence that we'll achieve our 2021 guidance.
Our Q2 performance was highlighted by 27% organic orders growth in our Industrial business as both short- and long-cycle demand remained strong.
We saw continued recovery across virtually all Industrial regions and end markets with orders exceeding pre-COVID levels.
Book-to-bill in Industrial was 1.2, consistent with the first quarter.
Despite some headwinds from inflation and COVID-related supplier issues, we delivered revenue and earnings in line with guidance.
Our free cash flow conversion was 115%, a sign that our efforts to improve working capital are taking hold.
Based on our strong orders performance in the first half, our $436 million backlog and all the work we've done to streamline our operations, we're well-positioned for a very strong second half.
And finally, we made significant progress on our strategic priorities.
I'll talk more about this later.
I'm excited about the momentum the team is building, especially around growth and margin expansion.
Let's start with the financial highlights on Slide 2.
Organic orders of $210 million in the quarter were up 4% versus prior year.
We saw a strong year-over-year increase of 27% in Industrial driven by improvements in virtually all of our end markets.
As expected, orders were down 31% in Aerospace & Defense due to the timing of large defense orders.
Our backlog remained strong at $436 million, up 4% sequentially.
Our backlog in Industrial is $248 million, up 26% since the end of last year.
Organic revenue was $190 million, down 2% versus prior year and up 5% sequentially.
Revenue came in as expected given the timing of orders and lead times across our portfolio.
Sequentially, Industrial was up 7% as revenue starts to ramp from strong orders in Q1 and Q2.
A&D was in line with prior quarter driven by timing of defense deliveries and a slowly improving commercial market.
Adjusted operating income was $14.6 million, representing a margin of 7.7%, up 80 basis points from previous quarter and down 80 basis points from prior year.
Finally, we delivered $0.35 of adjusted earnings per share and generated free cash flow of $8 million as the team continues to drive working capital improvements across the company.
Moving to Slide 3.
Industrial organic orders were up 27% versus last year and 1% sequentially.
Regionally, order growth was led by North America and Asia, and we saw improved project orders as customers start to increase capex spending.
Our book-to-bill ratio for the quarter and for the first half was 1.2, which will support double-digit second-half revenue growth and represents a revenue inflection point post-COVID.
As expected, Industrial organic revenue was down 1% versus last year and up 7% sequentially.
By region, we saw year-over-year strength in both EMEA and China, partially offset by lower revenue in North America.
Outside of these isolated issues, revenue was in line or better than expectations across our end markets.
Adjusted operating margin was 8%, down 200 basis points versus last year, which reflects the downstream volume and aftermarket mix challenges in the quarter.
Operating leverage, simplification and continued strategic pricing will drive strong second-half margin expansion.
Turning to Slide 4.
Aerospace & Defense orders of $54 million were down 31% versus last year and 26% sequentially.
Orders were lower versus prior year due to a large multiyear defense order for the Virginia class submarine.
Versus prior quarter, the lower orders were driven by the timing of large orders for the Joint Strike Fighter and CVN-80 and 81 aircraft carriers.
Lumpy defense orders were partially offset by a modest sequential and year-over-year improvement in commercial aerospace.
As expected, revenue in the quarter was $61 million, down 5% year over year and up 1% from prior quarter.
Looking to the back half, we're expecting double-digit organic revenue growth as we ramp deliveries on key defense programs.
Finally, operating margin was 19.9% in the quarter, down 120 basis points year over year.
The margin decline was driven by lower aftermarket revenue.
Sequentially, margins expanded 210 basis points due to pricing actions and material productivity.
We remain confident in our ability to expand margins through the remainder of the year with higher defense and aftermarket volume.
Turning to Slide 5.
Free cash flow in the quarter was $8 million, a significant improvement versus prior year.
Working capital was a source of cash primarily driven by improved AR collections through the quarter and the timing of customer down payments.
We paid down $40 million of debt in Q2 with free cash flow and the proceeds from the sale of a noncore industrial product line.
We ended the quarter with $451 million of net debt, and we are on track to improve our leverage by greater than one turn this year.
In the third quarter, we expect revenue to be up 8% to 10% organically.
For Industrial, deliveries will be heavily weighted to Q3 and Q4 as we ship the backlog that we built in the first half.
In A&D, the growth in the back half is driven by the ramp in defense program deliveries and a modest recovery in commercial aerospace.
Scott will cover this in more detail in the upcoming slides.
We're expecting adjusted earnings per share of $0.55 to $0.60 in the third quarter, a 53% to 67% increase versus prior year.
3Q free cash flow conversion is expected to be between 120% and 140%.
Inflation will be a headwind in the third quarter and second half, but we expect material productivity to offset any cost increases.
For the year, we are reaffirming the guidance that we provided during the first-quarter earnings call.
Organic revenue growth is expected to be in the range of 2% to 4%, with adjusted earnings per share of $2.10 to $2.30.
Free cash flow conversion remains at 85% to 95%.
We have high confidence in our second-half margin outlook, and we expect to exit the year with 4Q operating margin of 13% to 15% for the company.
As we head into the back half of the year, we are closely monitoring the impact of COVID-19 variants in our global end markets and operations.
Now I'll hand it back to Scott to discuss our market outlook.
Let's start with our Industrial outlook on Slide 7.
As Abhi mentioned, in the second quarter, we saw continued recovery across virtually all Industrial end markets with orders exceeding pre-COVID levels.
In Q3, we expect double-digit order growth versus prior year with a seasonal sequential decline.
For Q3 Industrial revenue, we expect solid improvement year over year with growth between 7% and 11%.
Improvement across our short-cycle end markets is expected to lead revenue growth as shorter lead time products in our backlog ship in Q3.
Aftermarket remained strong with a double-digit increase expected in the third quarter.
Our longer-cycle end markets are expected to be up 5% to 9%.
In downstream, we're expecting revenue more or less in line with last year.
We're encouraged by the orders and quoting activity we saw through July, and we've addressed the supplier issues that impacted us in Q2.
In Commercial Marine, orders and revenue are increasing as shipbuilding activity picks up from historically low levels.
Finally, pricing is expected to net roughly 1%, consistent with prior quarters.
Moving to Aerospace & Defense.
Orders in the second quarter were down sequentially and versus prior year driven by the timing of large defense program orders.
Q3 orders are expected to be in line with prior year, and we're expecting a significant increase in Q4.
Revenue in the third quarter is expected to be up 12% to 15% versus prior year.
Growth in defense revenue was primarily driven by strong volume on smaller OEM programs such as the Boeing P-8 Poseidon and various missile switch programs.
Revenue from our top OEM programs is expected to be up low to mid-single digits with growth across nearly all of our major platforms.
Year to date, aftermarket revenue has been trending below our expectations driven by delayed government spending.
Looking forward, we expect sequential growth in spares and MRO activity in both Q3 and Q4.
Commercial aerospace is expected to be up between 15% and 20% in the third quarter.
Revenue from commercial air framers will be up roughly 50%, mostly driven by increased A320 volume and favorable comparisons to last year.
Aftermarket is expected to be up roughly 30%, in line with increased aircraft utilization.
In both cases, narrow-body volume continues to lead the recovery.
Finally, pricing is expected to be a net benefit of 3% for defense and 5% for commercial due to price increases secured earlier in the year, a higher level of spot orders and an increase in commercial aftermarket volume.
Our full-year pricing outlook remains in line with last year.
As we did last quarter, I'd like to provide an update on our previously shared strategic priorities.
These priorities continue to guide what our team works on every day.
We're investing in growth.
We launched 21 new products through the first half of the year and remain on track to deliver 45 new products in 2021.
On the Aerospace & Defense side, we launched a new brushless DC motor and brake assembly, which actuates the vertical stabilizers and aileron flight control surfaces on a high-altitude, long-endurance surveillance drone operated by the U.S. Air Force.
On the Industrial side, we introduced a new control valve that was entirely designed, sourced and manufactured in India, the first of its kind for CIRCOR.
This flue gas desulfurization valve is not only compliant with the new clean air regulations for Indian power plants, but also positions CIRCOR as the sole local partner providing a total solution.
Next, our regional expansion strategy is gaining traction.
Our Industrial team recently won a large multiproduct pump order with Daewoo Shipbuilding in Korea.
By providing a complete solution, we were able to secure a position on a long-term submarine program and strengthen our relationship with the Korean Navy.
On margin expansion, we're building on our CIRCOR operating system and simplification program by kicking off 80/20 at three of our largest Industrial businesses.
We're still early in the process, but we're excited about the structured approach to accelerate margin expansion at CIRCOR.
Finally, as Abhi covered earlier, we made progress in reducing our total debt.
We'll continue to use free cash flow to pay down debt for the remainder of 2021.
Before we move to Q&A, I want to highlight a recent customer perception study for our Industrial business.
It was an independent global survey with participation from roughly 70 of our largest customers.
The results confirm that our strategic priorities are aligned with our customers.
Our Net Promoter Score of 67 is exceptional and is a testament to our product quality and technical customer support.
Given the mission-critical nature of our products and the high cost of failure, our customers have a strong preference to buy OEM spare parts, and price is one of the least important buying criteria.
This study illustrates the power of our differentiated product portfolio and confirms that our strengths are aligned with our customers' top priorities.
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circor delivers strong second quarter results and reaffirms 2021 guidance.
q2 adjusted earnings per share $0.35.
q2 revenue $190 million versus refinitiv ibes estimate of $189.2 million.
sees q3 adjusted earnings per share $0.55 to $0.60.
reaffirms fy adjusted earnings per share view $2.10 to $2.30.
sees q3 revenue up 10 to 12 percent.
for full year of 2021, circor reiterated its guidance of organic revenue growth of 2 to 4%.
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On the call, today, are Scott Buckhout, CIRCOR's president and CEO, and Abhishek Khandelwal, the company's chief financial officer.
The slides we'll be referring to today are available on CIRCOR's website at www.
These expectations are subject to known, and unknown risks, uncertainties, and other factors.
For a full discussion of these factors, the company advises you to review CIRCOR's Form 10-K, 10-Qs, and other SEC filings.
The company's filings are available on its website at circor.com.
Actual results could differ materially from those anticipated, or implied by today's remarks.
These non-GAAP metrics exclude certain special charges and recoveries.
CIRCOR delivered a strong third-quarter despite unprecedented macro challenges.
The work we've done to transform our portfolio during the last three years has paid off.
We now have a stronger more resilient portfolio of essential products.
Our diversification across geographies, and markets, and products is mitigating the ongoing weakness of the pandemic.
In addition, we've been able to raise prices through the downturn because our product portfolio has strong market positions and differentiated technology.
We're executing well through the downturn.
Our continued focus on productivity and cost resulted in a companywide decremental of 19% in the quarter.
The $45 million cost plan for 2020 that we communicated in May remains on track.
Our pricing initiatives remain on the plan in both Aerospace & Defense and industrial.
The CIRCOR operating system is delivering improved operating performance across most metrics, and we expanded the margin of our aerospace & Defense business by 360-basis-points in the quarter despite the lower volume.
Finally, we continue to take actions that best positioned CIRCOR to take advantage of a market recovery.
With 13 new product launches in Q3, we remain on track to deliver on our commitment to launching 45 new products this year.
We continue to invest in front-end resources and strategic growth initiatives.
We're closely collaborating with suppliers and customers to ensure alignment as markets change.
And finally, we continue to focus on deleveraging the balance sheet.
Now, I'd like to provide some highlights from the third quarter.
Please turn to Page 4.
We booked orders of $167 million, down 19% organically due to the impact of COVID-19 on our Industrial and Commercial Aerospace businesses.
Defense orders relatively low in the quarter due to the timing of large defense programs.
The growth outlook for defense remains strong.
Sales came in as expected at $187 million flat to the prior quarter and down 15% organically.
We continue to believe Q3 is the bottom for sales and orders.
We expect sequential improvement across both businesses in Q4, which we'll talk about in more detail later in the call.
Adjusted operating income was slightly more than $17 million, representing a margin of 9.3%, up 80-basis-points from the prior quarter, and down 130-basis-points from last year driven by lower sales volume in industrial.
The Companywide decremental was 19% in the quarter, which is significantly lower than our contribution margin driven by productivity, aggressive cost actions, and price.
Before I review the outlook for our end market.
Let's begin by reviewing our segment results.
All figures up from continuing operations and exclude divestitures.
Starting with industrial on Slide 5.
In Q3, Industrial segment orders were down 23% organically due to the impact of COVID-19 on most end markets.
Downstream orders were especially impacted in the quarter, due timing of capital projects and maintenance turnaround delays.
Excluding our Downstream business, orders an industrial were down 15% organically.
The benefit of the industrial portfolios regional diversity was evident in the quarter.
We saw sequential improvement in Germany, India, and China with orders increasing in the low double-digit range, partially offsetting pressure in North America.
While oil and capital projects remain depressed, we experienced a sequential improvement in the aftermarket side of the business on a global basis.
As expected, the industrial segment had sales of $124 million flat to the prior quarter, and down 18% organically.
The EOM margin was 7.9% down 210-basis-points sequentially, and a decline of 460-basis-points versus last year.
The margin decline versus the prior year was primarily driven by lower sales volume and the impact on productivity associated with the need to maintain social distancing.
Among other safety protocols on the factory floor, which was partially offset by cost actions and price.
In addition, one of our facilities in North America experienced a COVID-19 outbreak which forced us to idle the factory for most of August, and impacted our EOM by approximately $1.5 million in the quarter.
Adjusted for the $1.5 million of COVID impact, the industrial margin would have been 9.1%, and the decremental would be approximately 30%.
Turning to Slide 6.
In Q3, in our Aerospace & Defense segment, we delivered orders of $59 million, down 9% organically.
Orders were impacted by the timing of large defense programs in the quarter and the continued impact of COVID-19 on Commercial Aerospace.
While the timing of large defense programs resulted in lower orders in the quarter, the business remains strong overall, and we remain confident in the segment's strong growth outlook going forward.
Sales for the Aerospace & Defense were $62 million flat to the prior quarter, and down 9% organically.
Strengthened defense platforms partially offset the impact of COVID-19 on Commercial Aerospace.
The Aerospace & Defense operating margin was 23.7%, up 360-basis-points versus the prior year, and 260-basis-points sequentially.
With $6 million lower revenue, the Aerospace & Defense team delivered $1 million of incremental operating income, driven by price, productivity, and other aggressive cost actions.
Turning to Slide 7.
For Q3, the effective tax rate was approximately 13% lower than the 14.8% in the prior quarter, due to a change in the statutory tax rate where CIRCOR operates.
For Q4, the tax rate is projected to be approximately 15%.
The Company took a non-cash charge of approximately $42 million to create a valuation allowance against its remaining U.S. deferred tax assets.
This non-cash charge was acquired in the GAAP accounting rules, primarily due to recent U.S. tax law changes, and losses in the U.S. from our divested businesses.
This charge does not impact our non-GAAP tax results for the quarter and is not expected to have an impact on our future non-GAAP tax results.
Looking at special items and restructuring charges, we recorded a total pre-tax charge of $13 million in the quarter.
The acquisition-related amortization and depreciation were a charge of $12 million with the remaining million dollars being associated with restructuring activities in the quarter.
Interest expense for the quarter was $8 million, down $4 million, compared to last year.
This was a result of lower debt balances and a favorable interest rate of 25-basis-points.
Other income was a million-dollar charge in the quarter, primarily due to foreign exchange losses, partially offset by pension income.
Corporate costs in the quarter were $7.2 million, in line with previous guidance provided.
Turning to Slide 8.
Our free cash flow from operations was flat in the third quarter.
Right in line with what we guided in our Q1, and Q2 earnings call.
At the end of the third quarter, our net debt was at $468 million.
This represents a year-over-year debt reduction of $120 million dollars.
In Q3, we paid $52 million, and the revolver further reducing our debt balance and interest expense.
We expect to generate strong free cash flow in the fourth quarter and intend to use that cash to continue to pay down debt.
Now I will hand it back over to Scott, to provide some color on our end markets, and outlook.
Now, I'll provide an overview of what we're seeing in our end markets.
Please turn to Page 9.
Let's start with the industrial.
As Abhishek mentioned, the impact of COVID-19 continued through the third-quarter across most major industrial end markets.
For Q3, orders were down 7% on a sequential basis with both for market and aftermarket orders coming in slightly lower than Q2.
Large projects remain weak, due to ongoing delays in capital spending.
Regionally, we saw weakness in North America and most of Europe, offset by strength in Germany, China, and India across most major sectors.
As we mentioned in last quarter's earnings call, we believe that Q3 marks the bottom and we expect industrial segment orders and revenue to improve sequentially in Q4.
Both market and aftermarket orders are expected to increase double digits sequentially.
From an end market perspective, we expect slight sequential improvement in many of our larger end markets.
Power generation is showing early signs of improvement globally.
Downstream Oil & Gas orders are improving as high priority capital projects, and certain maintenance activity moves forward.
Our shorter cycles of chemical processing in markets that are more closely linked to consumer demand are showing slow improvement.
For industrial revenue in Q4, we expect a moderate improvement sequentially with growth ranging from flat to up 10%.
While year-over-year revenue is expected to be down between 5% and 15%.
Most OEM and aftermarket end markets are expected to improve in Q4, compared to Q3.
Downstream Oil & Gas revenue is expected to be up sequentially, due to the timing of project shipments and higher aftermarket activity in the quarter.
Regionally, we're seeing pockets of economic improvement in China, India, and Germany, which we expect to continue.
Commercial Marine and midstream Oil & Gas are expected to remain at low levels, due to depressed activity and shipbuilding, low ship utilization, and ongoing project delays in midstream Oil & Gas.
Overall, we expect Aerospace & Defense orders in Q4 to be in line with Q3 sequentially, and down versus the prior year driven by the timing and defense program orders, and ongoing COVID related headwinds in the Commercial business.
For Aerospace & Defense revenue in Q4, we expect a significant sequential improvement from Q3.
Defense revenue should see sequential growth of 20% to 25%, and year-over-year growth of 15% to 20%.
Growth in the quarter is driven by strong shipments across our Submarine portfolio, our missile portfolio, and for the Joint Strike Fighter.
Commercial revenue is expected to grow sequentially between 15% and 25%, but we'll be down year over year between 40% and 45%.
The sequential improvement is driven by slightly improving shipments across a variety of business jet, regional jet, and other civil platforms, partially offset by lower shipments to Boeing and Airbus.
The outlook for price remains strong with a net 4% increase for Defense and Commercial Aerospace, driven by improved price management.
To summarize, as the pandemic continues to significantly impact the global economy, CIRCOR remains committed to delivering long-term shareholder value.
Our portfolio transformation is largely complete.
We've completely exited upstream Oil & Gas, and the new CIRCOR is diversified across geographies, end markets, and product technologies.
Our portfolio of products has differentiated technology and strong market positions in the niches where they compete.
As a result, we're able to raise prices across the portfolio despite the current market conditions.
We remain focused on execution.
The $45 million cost plan for 2020 is on track.
Our focus on productivity and cost resulted in a companywide decremental of 19% in the quarter, and the CIRCOR operating system is delivering improved operating performance across most metrics.
Finally, we continue to take actions that best positioned CIRCOR to take advantage of a market recovery.
We remain on track to deliver on our commitment to launching a record of 45 new products this year.
We continue to invest in front-end resources and strategic growth initiatives.
We're closely collaborating with suppliers and customers to ensure alignment as markets change, and we continue to focus on deleveraging the balance sheet.
They've been doing an excellent job working every day to ensure that we continue our momentum and meet our customers' needs.
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q3 revenue $187 million versus refinitiv ibes estimate of $186.9 million.
remain on track to achieve $45 million 2020 cost reduction plan.
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I'm joined today by Scott Buckhout, CIRCOR's president and CEO; and Abhi Khandelwal, the company's chief financial officer.
These expectations are subject to known and unknown risks uncertainties and other factors, and actual results could differ materially from those anticipated or implied by today's remarks.
You can find a full discussion of these factors in CIRCOR's Form 10-K, 10-Qs and other SEC filings also located on our website.
2020 was another transformational year for CIRCOR.
And despite the continued challenges presented by COVID-19, our team made significant progress on executing our strategic plan.
I'm proud of the resilience and efforts of the entire CIRCOR team in navigating such a challenging year while continuing to deliver for our customers and shareholders.
s we saw throughout the year, our diversified product portfolio across multiple end markets and geographies helped mitigate the impact of a weaker macro environment.
Our defense business delivered strong results for the year, which mostly offset lower demand for our commercial products.
Our differentiated technology and market positions enabled us to increase prices across the portfolio.
We executed well throughout this year's downturn and exited the year with positive momentum.
With the health and safety of our employees as our foundation, we focus on the things we control.
We achieved decremental margins of 25% for the year through value-based pricing and difficult but necessary cost actions of $45 million.
Aerospace and defense improved their margins by 290 basis points despite lower volume.
Notably, aerospace and defense won 20 new programs, including 60 defense and four in commercial.
We continue to implement the CIRCOR operating system across the company, resulting in improved operational performance.
CIRCOR is well positioned to take advantage of an eventual market recovery in 2021 and beyond.
With the sale of instrumentation and sampling and distributed valves earlier in the year, our exit from upstream oil and gas is complete.
We continue to invest in innovation, launching 49 new products in 2020 versus 33 in 2019.
We delivered on our free cash flow commitments throughout the year and ended with strong free cash flow of $20 million in the fourth quarter.
And finally, we reduced our debt by $126 million or 22%.
I want to highlight some new mission-critical technology we introduced in 2020.
On the defense side, our new missile arming switches are designed to operate in more severe environments with respect to temperature, radiation and G-force.
We launched self arming switches in support of various missile programs, including hypersonic applications.
On the commercial side, we introduced a switch, which activates the aircraft's location transmitter in case of an in-flight emergency.
In industrial, we launched a series of new gas pressure reduction systems to help our customers in Marine, Medical and public utility industries.
These systems help our customers transport and manage high-pressure industrial gas, LNG and CNG, biomethane fuels and medical oxygen.
Now, I'd like to provide some financial highlights from the fourth quarter.
We booked orders of $168 million in the quarter, which was flat sequentially and down 25% organically.
Sequentially, industrial was up 12% in the quarter.
A&D had lower orders sequentially, down 21% and due to the timing of large naval program orders that pushed into 2021.
Revenue in the quarter was $208 million, up 10% sequentially, driven by strong defense deliveries, mainly on U.S. Naval programs and moderate growth across most end markets in industrial.
Adjusted operating income was $23 million, representing a margin of 11.2%, up 200 basis points from the prior quarter.
Margin improvement was driven by sequential volume recovery, pricing, cost actions and productivity.
As a result of improved operating income, the company delivered $0.66 of adjusted earnings per share.
Finally, we generated strong free cash flow of $20 million during the fourth quarter, as we exited the year with operational cash flow unencumbered by transformation disbursements.
We are providing both comparisons due to the significant impact of COVID-19 on our end markets and year-over-year comparison.
Starting with industrial on Slide 4.
In Q4, industrial segment orders were up 12% sequentially, down 22% organically.
The industrial segment saw a sequential recovery in all major end markets, driven by opening economies.
Revenue in the quarter was $131 million, up 4% from prior quarter and down 13% organically.
Sequential improvement was primarily driven by strength in aftermarket sales across the portfolio.
We exited the year with an operating margin of 9%, a sequential improvement of 160 basis points, driven by price increases and cost actions taken throughout the year.
Lower sales volume continued to drive a lower operating margin versus prior year.
Turning to Slide 5.
Our aerospace and defense segment booked orders of $47 million in the quarter, down 21% sequentially and down 33% versus prior year.
Both declines are primarily driven by timing of large defense program orders and the ongoing impact of COVID-19 on our commercial business.
We remain confident in the segment's growth outlook in 2021.
Revenue in the quarter was $78 million, up 25% from prior quarter.
Strong defense deliveries mostly offset the COVID-19 impact, on commercial Aerospace, resulting in only 3% lower revenues versus by year.
Finally, operating margin was 24% in the quarter, roughly flat sequentially and year over year.
Pricing, up 3%, combined with factory and cost actions drove strong margins in line with prior year despite lower revenue.
Moving to Slide 6.
For Q4, the effective tax rate was approximately 14%.
The company took a non-cash charge of approximately $15 million to record a valuation allowance against its remaining deferred tax assets in Germany.
This non-cash charge is acquired under GAAP accounting rules.
This charge does not impact our non-GAAP after tax results for the quarter and is not expected to have an impact on our future non-GAAP after tax results.
Looking at special items and restructuring charges, we recorded a total pre-tax charge of $13.4 million in the quarter.
The acquisition-related amortization and depreciation was a charge of $12 million with the remaining charges associated with restructuring activities in the quarter.
Interest expense for the quarter was $8.5 million, down $2.3 million compared to last year as a result of lower debt balances.
Other income was approximately $1 million, primarily driven by pension income.
Finally, corporate costs were $7.8 million in the quarter.
Turning to Slide 7.
As Scott mentioned previously, our free cash flow was $20 million in the fourth quarter, up 11% compared to 2019.
Free cash flow was positively impacted by improved operating income and lower working capital, particularly inventory.
Reducing working capital remains one of our top priorities, and we expect further improvement in 2021.
We used the proceeds from the sale of our instrumentation and sampling business to reduce our net debt to $443 million, a reduction of $126 million or 22% year over year.
Free cash flow generated in 2021 will be used to further pay down debt and we continue to target leverage ratio of two to two and a half tiems net debt to adjusted EBITDA.
Now, I will hand it back over to Scott to provide some color on our end markets.
Let's start with our industrial outlook on Slide 8.
As Abhi mentioned, signs of order recovery were evident in the fourth quarter across most major industrial end markets after hitting the bottom in Q3.
Geographically, we continue to see growth in China and India, and we started to see signs of recovery in Europe and North America in the quarter.
Downstream orders were up sequentially, driven by an increase in aftermarket orders, but down significantly versus last year due to a difficult compare.
We're expecting Q1 industrial revenue to come in between down 1% and up 4% year over year.
We expect to see a normal seasonal dip in revenue sequentially in Q1 versus Q4.
We're starting to see improvement in our short-cycle end markets, including machinery manufacturing, chemical processing and wastewater as consumer demand starts to improve.
We're also expecting a mid-single-digit increase in aftermarket as global economies open up and consumption increases.
Downstream oil and gas revenue is expected to be down as refiners continue to manage capex.
We're seeing a similar customer capex dynamic across midstream oil and gas, power generation and building construction, but to a lesser degree.
We expect these end markets to improve further as the year unfolds.
Pricing is expected to be a benefit of roughly 1%, consistent with prior quarters.
Moving to aerospace and defense.
aerospace and defense orders in Q4 were down sequentially and versus prior year.
Both declines were primarily driven by the timing of large defense program orders and the ongoing impact of COVID-19 on our commercial businesses.
We expect order strength across our defense programs to continue through 2021, driven largely by the joint strike fighter and multiple missile and drone programs.
We expect a modest improvement in commercial orders as aircraft utilization improves and OEM production rates increased through the year.
We remain confident in this segment's growth outlook in 2021.
Revenue in the first quarter is expected to be down 7% to 12% versus prior year.
defense revenue is expected to be down 1% to 5% due to the timing of large defense shipments and lower U.S. defense spares orders leading into the quarter.
We anticipate growth of 5% to 10% from our other OEM group, which includes products for drones, missiles and helicopters.
in the Rafal fighter and jet in Europe.
Commercial revenue is expected to be down between 35% and 40%, in line with the broader commercial aerospace market.
Our market position on both Boeing and Airbus aircraft is strong, and we expect revenue to improve throughout the year in line with aircraft utilization and production rates.
Pricing is expected to be a benefit of 1% in the quarter, but in line with 2020 for the full year.
Now, I'll hand it over to Abhi to discuss our guidance.
Before jumping into full-year guidance, I'd like to share a few more expectations for the first quarter.
In addition to the revenue guidance that Scott provided, we're expecting incremental margins of 30% to 35% in industrial and decremental margins of 30% to 35% in aerospace and defense.
Decremental margins in aerospace and defense are slightly higher than our full-year 2020 decrementals due to the expected mix of OEM and aftermarket revenue.
We're also planning for corporate cost of $8.5 million, higher than our expected full-year run rate, due to the timing of certain expenses, such as RFPs.
Interest expense is expected to be roughly $8.5 million in Q1.
Finally, free cash flow for Q1 will be negative due to seasonality of annual disbursements.
Now, moving to full-year 2021 guidance.
We are expecting organic revenue growth of 0% to 4%, and with aerospace and defense expected to grow at low to mid-single digits and industrial at low single digits.
We are planning for a continued slow recovery in commercial Aerospace, where we expect to be better than 2020, but remain significantly lower than pre pandemic levels.
Our defense business remains healthy as we continue to win new business and deliver on growing U.S. defense programs.
In our industrial end markets, we expect to see modest recovery with downstream activity improving in the back half of 2021.
We're expecting adjusted earnings per share of $2 to $2.20, a 40% to 54% increase versus 2020.
This improvement is driven by top-line growth and improved margins from price increases, structural cost out in 2020 and ongoing productivity.
Finally, we're planning to deliver free cash flow as a percent of adjusted net income of 85% to 95%.
We feel that this guidance reflects what we are seeing in our end markets and the operational improvements that we can control within the four walls of CIRCOR.
We're confident in our ability to deliver these results, not only for our shareholders but for our customers, suppliers and employees.
Now I'll hand back to Scott to wrap up.
To summarize, we remain focused on delivering our strategic priorities.
In 2021, we're taking actions to further improve our customers' experience and our operational and financial performance.
We remain focused on attracting, developing and retaining the best talent while fostering a diverse and inclusive culture.
We continue to invest in growth through innovative new products, aftermarket support technology to enhance our customers' experience and regional expansion.
Value-based pricing continues to be a top priority, leveraging our differentiated technology and our strong market positions in the niches where we compete.
The CIRCOR operating system will continue to drive operational improvement and margin expansion.
And by enhancing free cash flow through efficient working capital management, we'll continue to delever the balance sheet.
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compname reports q4 adjusted earnings per share $0.66.
q4 adjusted earnings per share $0.66.
q4 revenue $208 million versus refinitiv ibes estimate of $207.6 million.
for 2021, expects organic revenue growth in range of 0 to 4%.
for 2021, adjusted earnings per share is expected to be in range of $2.00 to $2.20.
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I'm Alexis Jones, Lead Principal for Investor Relations.
In our remarks today, David and Brian will cover a number of topics, including Cigna's third quarter 2021 financial results, as well as an update on our financial outlook for 2021.
We use term labeled adjusted income from operations and adjusted earnings per share on the same basis as our principal measures of financial performance.
Before turning the call over to David, I will cover a few items pertaining to our financial results and disclosures.
Regarding our results, in the third quarter, we recorded an after-tax special item benefit of $35 million or $0.10 per share for integration and transaction related costs.
Additionally, please note that when we make prospective comments regarding financial performance, including our full-year 2021 outlook, we will do so on a basis that includes the potential impact of future share repurchases and anticipated 2021 dividend and does not assume any impact from any business combinations or divestitures that may occur after today, such as our recently announced planned divestiture of life accident and supplemental benefits businesses outside of the U.S., which we expect to close in 2022.
So, let's jump in.
During the quarter, we delivered adjusted revenue of $44 billion and adjusted earnings per share of $5.73 per share, all while continuing to reinvest back in our business to fund growth, expansion and ongoing innovation, and we continue to return significant value to our shareholders.
These results reinforce we are delivering for our customers, our patients, clients provider partners, as well as for you, our shareholders.
With our high performing health service portfolio and sharp focus on executing our strategy, we are confident in our ability to continue driving growth and are again raising our full-year 2001 guidance for adjusted earnings per share and revenue.
Our performance is strong considering the ongoing impact of the pandemic on medical costs, as well as the higher claims we've experienced among the special enrollment period or SEP customers within our individual business.
As it relates to our MCR in the quarter, our commercial business did improve from the second quarter to the third quarter and our Medicare Advantage business also improved sequentially.
We continue to execute a series of actions in 2021 and 2022 to further improve our MCR, and Brian will walk through this in more detail in a few moments.
Separately, in early October we also announced an agreement with Chubb to sell our life, accident and supplemental benefits business in our International Markets platform in seven countries for $5.75 billion.
We expect to realize about $5.4 billion in net after-tax proceeds and complete the transaction in 2022 following regulatory approvals.
Guided by our strategy and similar to our 2020 divestiture of our Group Insurance business, this transaction unlocks the value of a best-in-class leading asset, while also enabling us to even more sharply focus our business on health and well-being services.
So overall, our performance for the quarter reflects our clear strategy and strong execution and delivering attractive results and importantly, our ongoing commitment to prioritize and support the evolving health and well-being needs of those we serve.
Now, I'll walk through some additional detail for our Evernorth in U.S. Medical businesses.
A year ago, we launched Evernorth to the marketplace as our health service platform, focused on servicing health plans, employers, government organizations and healthcare providers.
Since that time, Evernorth has established itself with unique partnerships and innovative services that are resonating with multiple buyer groups.
Our Evernorth pharmacy and our medical offerings through our U.S. medical platform are the two primary gateways through which most of our clients and customers form their base relationship with us.
Wrapping around these two exceptionally strong platforms are our additional suites of innovative health services Evernorth, including benefits management, care solutions and intelligent solutions.
These help us to expand and deepen existing relationships.
In the third quarter, Evernorth retained and expanded our relationship with the Department of Defense TRICARE pharmacy program and we did seven-year contracts.
It's our privilege to serve almost 10 million active duty service members, retirees and their families.
Evernorth will continue supporting TRICARE pharmacy operations including specialty pharmacy services, military pharmacy claims and retail network pharmacies.
The new contract also allows for expansion of specialty and care coordination services through 2029.
As we look to the balance of the year and into 2022, Evernorth will continue to grow revenue and earnings.
Turning to our U.S. medical platform.
In U.S. commercial, our teams are leveraging and deploying the innovative solutions from Evernorth to expand our service offerings and address the evolving needs of our clients and customers.
For example, in our U.S. commercial platform, we are leveraging Evernorth and the live capabilities to expand virtual care options for our customers through their employers, with primary, urgent, behavioral and dermatology care as part of these value-based arrangements during virtual visits and the live physicians are leveraging our Evernorth Intelligence capabilities, enabling them to provide more connected and coordinated experience, and we continue to expand our capabilities with MDLIVE as we recently launched a virtual first health plan for employers.
Another great example of Evernorth in U.S. commercial partnering to bring more value to our health plan clients is a new arrangement we have with University of Pittsburgh Medical Center Health plan.
We will make in network care available to UPMC customers who live, work or travel outside the network service area.
UPMC has been an Evernorth pharmacy client for 16 years and this agreement illustrates how we are collaborating across our enterprise to deliver greater affordability and differentiated value for health plan clients.
We are pleased how the market continues to recognize the value we're delivering through our broad suite of solutions and as such, we continue to grow through both our U.S. commercial and Evernorth platforms.
Within Medicare Advantage, consistent with our strategy, we continue to grow in our existing markets and are expanding into new geographies.
Our progress is further supported by our overall value of our offerings.
For 2022 calendar year, 89% of our Medicare Advantage customers will be in four star or greater plans nationally.
This is the highest level we've ever achieved and it marks the fifth year in a row we've improved our STARS performance.
And in our individual and family plan business, we've driven strong growth in this year, increasing customers by 47% through the third quarter.
A substantial portion of this growth did come from the extended special enrollment period.
And as I previously noted, some of the MCR impact in the third quarter was driven by the medical costs among those we added during the outpaced SEP growth.
We do expect this will moderate in 2022.
We are positioning ourselves to build on this momentum in the individual family plan business by expanding our addressable markets, again as we enter in three new states and 93 new counties in 2022.
These new markets offer the potential to reach an additional 1.5 million customers.
The continued strength of our results and the growth we are generating through the execution of our strategy gives us confidence we will deliver against our commitments in 2021.
We will deliver earnings per share in line with our long-term targets and revenue growth well above our long-term targets for yet another year.
We will also deliver earnings per share within our long-term target range in 2022.
Specifically for 2021, we are committed to delivering our increased guidance for full-year adjusted earnings per share of at least $20.35.
For full year 2021, we remain on track for generating at least $7.5 billion of cash flow from operations and we expect to return more than $7 billion to shareholders in 2021 through dividends and share repurchase.
Looking into 2022, we expect to grow earnings per share by at least 10% off of our increased 2021 guidance of at least $20.35 per share.
We anticipate a number of tailwinds, including core growth in our business and additional contribution from margin expansion in our U.S. medical business as we drive pricing actions, execute affordability and efficiency initiatives and benefit from the return of Medicare risk adjustment revenue to more normalized levels.
We're also expecting year-over-year headwind as we plan for net investment income to be more in line with historical levels.
And of course, the rate and pace of ongoing strategic investments will vary from year to year.
In short, 2022 will be another strong year for Cigna.
Now to briefly summarize.
As we demonstrated through the quarter and throughout 2021, we are delivering for our customers, patients, clients and provider partners as they experience the ongoing challenges of the pandemic.
We are also taking significant value-enhancing actions such as divesting a portion of our international business, returning substantial amounts of capital to our shareholders and continuing to strategically invest in our capabilities and strategic partnerships, all of which position us to continue to advance our long-term growth agenda and continue to deliver shareholder value.
Today, I will review key aspects of Cigna's third quarter results, including the ongoing impact of COVID-19 on our business and I will discuss our updated outlook for the full year.
During the quarter, total medical costs were higher than our expectations within our U.S. Medical segment, driven largely by the impact of the Delta variant in our U.S. commercial business and increased medical costs for special enrollment period customers in our U.S. individual business.
Importantly, I would remind you that approximately 80% of our revenues are from service-based businesses that are not significantly exposed to medical cost fluctuations.
Our balanced portfolio and multiple levers for value creation resulted in Cigna's overall revenue and earnings exceeding our third quarter expectations.
This strong third quarter performance coupled with capital deployment activities led to an increased outlook for full year 2021, which I will discuss shortly.
Now turning to enterprise results.
Key consolidated financial highlights in third quarter 2021 include adjusted revenue growth of 9% to $44.3 billion, adjusted earnings growth of 20% to $1.9 billion after tax, and adjusted earnings-per-share growth of 30% to $5.73.
Results in the third quarter reflect strong top and bottom line growth with contributions across all of our businesses with overall performance above our expectations.
I'll now discuss our segment level results and will then provide an update on the details of our outlook as well as our capital positioning.
Regarding our segments, I'll first comment on Evernorth.
Third quarter 2021 adjusted revenues grew 13% to $33.6 billion.
Adjusted pharmacy script volume increased 8% to 411 million scripts and adjusted pre-tax earnings grew 7% to $1.5 billion compared to third quarter 2020.
Evernorth's strong results in the quarter were driven by organic growth, including strong volumes in retail and specialty pharmacy along with ongoing efforts to improve affordability for the benefit of our clients, customers and patients and deepening of existing relationships, partially offset by significant strategic investments to support ongoing growth, including our virtual care platform and technology capabilities.
Overall, Evernorth continues to create differentiated value for clients and customers, while driving overall revenue and earnings growth that exceeded our original expectations through the first three quarters of 2021.
Turning to U.S. Medical.
Third quarter adjusted revenues were $10.5 billion and adjusted pre-tax earnings were approximately $1 billion.
Overall, our U.S. Medical earnings exceeded our expectations during the third quarter, reflecting the impact of favorable net investment income and increased specialty contributions, partially offset by higher claim costs due to the net impact of COVID-19 and increased medical costs for special enrollment period customers in our individual business.
The net effect of these claim cost impacts produced a medical care ratio of 84.4% in the third quarter.
Looking ahead, we are actively managing overall medical costs and our MCR with the range of actions, including continuing to leverage our insights from our strong data and analytics capabilities to address key drivers and identify opportunities such as guiding customers to more effective and efficient sites of care, continued disciplined in our pricing and rate actions and we're also continuing to promote preventative care and access to behavioral services to provide meaningful support to patients and moderate overall medical costs over the longer-term.
Turning to membership, w ended the quarter with 17 million total medical customers, an increase of approximately 368,000 customers year-to-date.
In U.S. Medical, the year-to-date customer growth was driven by net growth in select and new markets within U.S. commercial and continued organic growth in Medicare Advantage and Individual within U.S. government.
In our international markets business, third quarter adjusted revenues were $1.6 billion and adjusted pre-tax earnings were $250 million.
These results were in line with our expectations.
Corporate and Other operations delivered a third quarter adjusted loss of $275 million.
Overall, Cigna's broad portfolio of services continues to serve the needs of our customers and clients.
Cigna remains committed to delivering value for all of our stakeholders, leveraging our well-positioned businesses.
Now turning to our updated outlook for full year 2021.
We are raising our adjusted earnings per share guidance for full-year 2021 to at least $20.35 per share, reflecting the strength of the quarter, the favorable impact of our year-to-date share repurchase and acknowledgment of the ongoing fluidity of the broader environment.
This represents earnings per share growth of at least 10% from 2020, consistent with our long-term earnings per share growth range of 10% to 13%, even with the ongoing challenges associated with COVID-19 and while having significantly increased our dividend in 2021.
As we look forward, it is clear that COVID-19 will continue to have an impact in the fourth quarter and in 2022.
And as time progresses, COVID-related impacts and the ongoing performance of the business are becoming more intertwined.
Therefore, we no longer believe it constructive to continue to quantify the impact of COVID-19.
These dynamics are fully contemplated in our 2021 expectation for adjusted earnings per share of at least $20.35 and our 2022 expectation for earnings per share growth of at least 10% off this 2021 guidance.
We now expect full-year 2021 consolidated adjusted revenues of at least one $172 billion, representing growth of at least 11% from 2020, when adjusting for the divestiture of our Group Disability and Life business.
I would note this revenue growth rate significantly exceeds our projected long-term average annual growth goal of 6% to 8% and represents a third consecutive year of significant revenue outperformance since our combination with Express Scripts in late 2018.
I will now discuss our 2021 outlook for our segments.
For Evernorth, we continue to expect full-year 2021 adjusted earnings of at least $5.8 billion, representing growth of at least 8% over 2020, reflecting the significant value we create for our customers and clients.
For U.S. Medical, we continue to expect full-year 2021 adjusted earnings of at least $3.5 billion.
Underlying this updated outlook, we now expect the 2021 medical care ratio to be in the range of 84% to 84.5%, which includes our expectations for elevated medical costs for Individual special enrollment period customers.
Regarding total medical customers, we continue to expect 2021 growth of at least 350,000 customers.
Now, moving to our 2021 capital management position and outlook.
We expect our businesses to continue to drive strong cash flows and returns on capital even as we continue reinvesting to support long-term growth and innovation.
For full-year 2021, we continue to expect at least $7.5 billion of cash flow from operations, reflecting the strong capital efficiency of our well-performing businesses.
Year-to-date, as of November 3, 2021, we have repurchased 26.5 million shares for $6.3 billion and we now expect full-year 2021 weighted average shares of approximately 342 million shares.
This includes the impact of the $2 billion accelerated share repurchase that we announced in the third quarter.
On October 27th, we declared a $1 per share dividend payable on December 22nd to shareholders of record as of December 7th.
Our balance sheet and cash flow outlook remains, benefiting from our highly efficient service-based orientation that drives strategic flexibility, strong margins and attractive returns on capital.
So now to recap.
Results in the third quarter reflect strong top and bottom line growth with solid contributions across our businesses.
Cigna has shown the ability to deliver value through dynamic environments with our breadth of businesses and multiple earnings levers we continue to support our customers, clients and coworkers and deliver on our financial commitments.
We now expect 2021 full-year adjusted earnings of at least $20.35 per share, representing growth of at least 10% from 2020 consistent with our long-term earnings per share growth rate range of 10% to 13%, and we expect to grow 2022 adjusted earnings per share at least 10% off our raised 2021 guidance.
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cigna sees fy 2021 adjusted rev to be at least $172 bln.
qtrly earnings per share $4.80; qtrly adjusted earnings per share $5.73.
sees fy 2021 adjusted revenues to be at least $172 billion; sees fy 2021 consolidated adjusted income from operations at least $6.96 billion.
adjusted income from operations for 2021 is now projected to be at least $20.35 per share.
medical care ratio of 84.4% for q3 2021 compares to 82.6% for q3 2020.
sees fy 2021 medical care ratio of 84.0% to 84.5%.
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I'm Ralph Giacobbe, senior vice president of investor relations.
In our remarks today, David and Brian will cover a number of topics, including Cigna's fourth quarter and full year 2021 financial results, as well as our financial outlook for 2022.
We use the term labeled adjusted income from operations and adjusted earnings per share on the same basis as our principal measures of financial performance.
Before turning the call over to David, I will cover a few items pertaining to our financial results and disclosures.
First, as previously disclosed with our Form 8-K filing and investor call on January 24, we announced changes in our segment reporting effective for the fourth quarter of 2021.
These changes were made to align with the company's organizational structure as a result of the pending divestiture of Cigna's international life accident and supplemental benefits businesses in seven Asia Pacific markets.
Effective in the fourth quarter, Cigna's results will be reported through the following three groups: Evernorth, Cigna Healthcare, and corporate and other operations.
The international health business to be retained by Cigna will join our U.S. commercial and U.S. government offerings in a new segment called Cigna Healthcare.
This segment replaces the prior U.S. medical segment.
Second, regarding our results.
In the fourth quarter, we recorded an after-tax special item charge of $119 million or $0.36 per share related to a strategic plan to further leverage the company's ongoing growth to drive operational efficiency through enhancements to organizational structure and increased use of automation and shared services.
We also recorded an after-tax special item charge of $70 million or $0.21 per share for integration and transaction-related costs.
Additionally, please note that when we make prospective comments regarding financial performance, including our full year 2022 outlook, we will do so on a basis that includes the potential impact of future share repurchases and anticipated 2022 dividends.
Also, our full year 2022 outlook assumes that the pending divestiture of Cigna's international life accident and supplemental benefits businesses will close in the second quarter of 2022, but does not assume any impact from other business combinations or divestitures that may occur after today.
Finally, I would like to announce our intention to host an Investor Day in June where we will discuss our long-term strategic growth and value creation story.
We look forward to sharing more details in the coming weeks.
As we step into 2022, our clients, customers, and patients continue to face a rapidly changing landscape with new COVID variants, changing testing and treatment protocols, and pressures on the global economy.
Throughout these challenges, we remain focused on addressing and balancing the evolving needs of all of our stakeholders.
As a result, our 70,000-plus colleagues around the world continue to deliver differentiated value for those we serve and also continue to grow our businesses.
Today, I'll share a perspective around our 2021 performance and the sustained growth opportunities we see for our organization in the year ahead.
And Brian will provide additional details about our 2021 financial results and our 2022 outlook.
With that, let's get started.
In 2021, we grew full-year adjusted revenues to $174 billion, a second consecutive year of growth above our long-term target.
We delivered full-year adjusted earnings-per-share growth of 11% and to $20.47, and we returned over $9 billion to shareholders in dividends and share repurchases.
Additionally, we continue to invest in our capabilities to ensure we are positioned for sustained growth in 2022 and beyond.
Our growth is and will continue to be fueled by our two high-performing platforms: Evernorth, our health services business, including pharmacy, care, benefits, and intelligence services; and Cigna Healthcare, which includes our portfolio of U.S. commercial, U.S. government, and international health businesses.
Our Evernorth and Cigna Healthcare platforms complement each other through the breadth of their capabilities and the ability to serve multiple buyer groups.
Here, we typically lead with either a medical or pharmacy solution and then we build on those relationships by innovating and delivering new services.
We have a proven track record with this approach, a diverse, high-performing portfolio of solutions, and a sustained commitment to continued innovation to expand that portfolio.
Additionally, we are positioned so that accelerated growth in one area can compensate for temporary pressure in another business within our portfolio.
We see this as extremely valuable in a dynamic environment.
Relative to our 2021 performance, it was a very strong year for Evernorth.
We grew adjusted revenues by 14% in 2021 as Evernorth's corporate clients, health plans, governmental agencies, and healthcare delivery system partners increasingly recognized the value of our health services, including in our specialty pharmacy business, which I'll discuss in more detail in just a moment; in our virtual health capabilities, which have been expanded through MDLIVE to include urgent and dermatology care as well as behavioral health services; in our core pharmacy services portfolio, which continues to generate outstanding results for our clients; and we are further broadening our reach through deeper and new partnerships.
government, and international health businesses.
As we previously discussed, we also experienced elevated medical costs.
We had higher claims costs in our commercial insured and stop-loss businesses and continued higher claims from our special enrollment Perry customers within the individual business.
These included the impact of elevated COVID costs for testing treatment of vaccines.
The elevated trend continued throughout the year.
As a result, our medical care ratio for Cigna Healthcare was 84% for full year 2021.
As Brian will discuss in further detail, we took targeted pricing and affordability actions earlier in 2021 for 2022 impact, as we continue to prioritize margin expansion for 2022.
As I highlighted earlier, the breadth and complementary nature of our portfolio enabled us to exceed our revenue and earnings per share outlook and return over $9 billion of capital to our shareholders.
Looking forward to 2022, we expect to continue to capitalize on emerging growth opportunities and achieve sustained attractive performance.
We see additional opportunities to drive growth by leveraging Evernorth capabilities to respond to three forces that we believe are fundamentally reshaping the future of healthcare.
They are pharmacological innovation, the increased recognition of the link between mental and physical health; and third, the growing trend toward alternative sites of care.
I'll start by highlighting how Evernorth will lead the way to capitalize on the first trend, pharmacological innovation.
New drugs represent one of the most promising areas for medical innovation in the coming years.
And we're seeing good dramatic growth in specialty pharmaceuticals, gene therapies, and vaccines.
These potentially life-saving and life-changing advances also bring intensifying pressures on affordability.
This creates significant opportunity for Evernorth to provide customers, patients, and clients with the most innovative new therapies in ways that are accessible, affordable, and predictable.
By 2025, for example, 66 biologic drugs currently in the market will have the patents expire, opening the door for increased biosimilar competition and an increasing opportunity to decrease healthcare spending by an estimated $100 billion.
Importantly, this trend is already unfolding in 2022 and will accelerate further in 2023.
We are positioned to lead and fully intend to capture a large portion of those savings for the benefit of our customers, patients and clients by combining and coordinating capabilities that include our Accredo capability, which provides differentiated specialty pharmacy care for a number of specific conditions.
I'd also highlight that today, specialty pharmacy already drives only one-third of our North revenue, and Accredo is one of the fastest-growing parts of our health service portfolio.
Additionally, leveraging Express Scripts, which draws upon its expertise in delivering improved affordability, leveraging a broad network, supply chain expertise as well as clinical and service capabilities.
Managing biologics and specialty drugs is also a priority focus for our Cigna Healthcare business.
Last year, we launched an innovative program to leverage biosimilars in the medical benefit that included incentives that improve access for integrated clients and customers.
This illustrates just one way we will continue to leverage Evernorth's capabilities to drive greater affordability and value for our Cigna Healthcare clients and customers.
Evernorth will also continue to grow from the significant demand for more mental health services as well as the rapidly changing access to care models.
For example, Evernorth is continuing to expand our virtual care services by leveraging our MDLIVE platform as well as expanding our behavioral care network.
We know how important it is for both patients as well as clients.
Our Evernorth research reinforces that total healthcare costs decrease when people who are diagnosed with behavioral conditions receive coordinated, sustained treatment.
For Cigna Healthcare in 2022, we expect to drive customer growth in each of our U.S. commercial market segments and grow earnings as we continue executing on our affordability and pricing actions throughout 2022.
Additionally, Cigna Healthcare will continue to partner and leverage our Evernorth innovations.
For example, we're continuing to expand digital experiences to help our customers connect with the highest performing and most affordable medical care.
Our recent approach we developed for patients diagnosed with orthopedic and musculoskeletal conditions provide highly personalized and actionable information to guide their choices and support improved healthcare outcomes and affordability.
In the U.S. government business, as we've noted previously, we are operating in a more competitive environment stepping into 2022.
government business for 2022.
For Medicare Advantage, we will start the year with flat membership.
Looking forward to 2023, we are confident in our position to accelerate growth further, as our customer satisfaction metrics are high, our Star's ratings are very strong, and we steadily expanded our addressable market by entering new geographies.
In our individual and family plan business, as noted previously, 2021 customers grew meaningfully in part due to the extended special enrollment period.
We expect a decline in customers in 2022, in part driven by our product and price positioning that will adjust for the special enrollment surge we saw in 2021.
We do continue to view this as an attractive long-term opportunity.
And to support that growth, we continue to enter new markets.
For 2022, we entered three new states and 93 new counties.
With these markets, for example, we have the ability to reach an additional 1.5 million additional customers.
In international health, we are sharpening our focus, and we'll continue developing our services for the globally mobile as well as go deeper into domestic health and health services.
One of the key ways we will do this is with innovative partnerships such as Honeysuckle Health, an analytics-driven health service company establishing our joint venture with the nib Group in Australia.
Now taken as a whole, 2022 will be another year of attractive growth for our company.
Our earnings per share outlook of at least $22.40 and the increase of our quarterly dividend by 12% reinforces the sustained growth and strength of our businesses.
Now before I wrap up, I want to reinforce a key aspect of our sustained performance is our positioning strategically to further expand our reach in addressable markets over time.
Here, we will leverage organic partnerships and targeted inorganic opportunities to further strengthen our proven growth platforms.
We see three areas of continued focus here.
First, in U.S. government, we will seek additional growth opportunities and our ability to win in these markets is further enhanced by our current and expanding Evernorth service capabilities.
Second, we will further expand our Evernorth service portfolio.
This includes, for example, our Evernorth care capabilities, including virtual home and behavioral services.
And third, in international health, our decision to divest our life accident supplemental benefits business in seven markets reinforces our discipline to focus on the health portion of our portfolio.
Now to wrap up.
Looking back at 2021, our business performed in a dynamic environment.
We delivered adjusted earnings per share of $20.47 and returned over $9 billion of capital to our shareholders in dividends and share repurchase.
2022 will be another year of growth across our business, and we will continue to invest in innovation to position us for sustained long-term growth.
Today, I'll review key aspects of Cigna's fourth quarter 2021 results, and I'll provide our outlook for 2022.
Key consolidated financial highlights for full year 2021 include adjusted revenue growth of 9% to $174 billion or growth of 12% when adjusting for the sale of the group disability and life business.
Adjusted earnings of $7 billion after tax and adjusted earnings-per-share growth of 11% to $20.47.
We delivered these results despite an elevated medical care ratio in the quarter partly driven by COVID-19-related claims.
Our enterprise revenue and earnings per share results were slightly better than our expectations, reflecting the resilience and breadth of our portfolio, with particularly strong performance in Evernorth.
Regarding our segments, I'll first comment on Evernorth.
Fourth quarter 2021 adjusted revenues grew 15% to $35.1 billion, while adjusted pre-tax earnings grew to $1.6 billion.
Evernorth's strong results in the quarter were driven by organic growth, including strong volumes in specialty pharmacy and retail, along with ongoing efforts to improve affordability and deepening of existing relationships.
In the quarter, we also continued to increase the level of strategic investments to support ongoing growth of the Evernorth portfolio, such as our Accredo specialty pharmacy, our virtual care platform, and our technology, including digital capabilities.
Overall, Evernorth delivered a strong year, focusing on driving value for clients and customers, while achieving strong revenue and earnings growth above its long-term growth targets.
medical segment plus our retained international health business.
Overall, fourth-quarter adjusted revenues were $11.2 billion, adjusted pre-tax earnings were $472 million and the medical care ratio was 87%.
During the fourth quarter, we experienced elevated medical costs, driven in large part by dynamics related to COVID, including higher testing, treatment, and vaccine costs, specifically the higher-than-expected fourth-quarter costs are attributable to three primary areas: higher stop-loss claims, particularly in policies with lower attachment points that were triggered by the cumulative impact of COVID and non-COVID costs throughout the year; continued pressure on our individual business, particularly the special enrollment period customers who were added in mid-2021; and higher claim costs in our commercial insured book.
The elevated medical costs were partly offset by better-than-expected net investment income and fee-based specialty contributions, neither of which are reflected in the medical care ratio metric.
For full year 2021, we finished with the medical care ratio of 84%.
The unfavorable fourth quarter medical costs informed and sharpened our 2022 assumptions.
We now expect full year 2022 medical costs to run above the corresponding 2022 baseline at a relative level that is consistent with full year 2021.
This 2022 medical cost outlook is now higher than our previous expectations.
In specific to stop-loss, we assume the pressure experienced in the fourth quarter will persist in 2022, and we will take appropriate future pricing action as this book of business renews throughout the year.
Helping to offset these pressures, as we step into 2022, our targeted pricing actions we've taken in our U.S. commercial business as we saw claim costs emerge in 2021, higher U.S. commercial enrollment and retention than previously expected in our fee-based business and incremental affordability actions, which I'll elaborate on in just a few moments.
We ended the year with 17.1 million total medical customers, an increase of approximately 430,000 customers for the full year.
government and international health.
Overall, Cigna Healthcare supported and delivered for our customers, clients, and partners during a challenging year and is well-positioned to both grow membership and expand margins in 2022.
Turning to corporate and other operations.
The fourth-quarter adjusted loss was $115 million and now includes positive earnings contributions from our international life accident and supplemental benefits businesses held-for-sale pending divestiture.
As Ralph noted, during the fourth quarter, we reported a special item charge of $119 million after tax related to actions to improve our organizational efficiency.
These actions will capitalize on our scale and the progress we have made through automation, increased use of digital tools, and continued innovation to better enable us to grow and expand in this dynamic marketplace.
Overall, Cigna's 2021 results reflect our balanced portfolio and our commitment to accretive capital deployment to augment our organic growth.
As we turn to 2022, our affordability initiatives, pricing actions, and focus on operating efficiencies will drive income growth and margin expansion in Cigna Healthcare.
This performance coupled with continued growth in Evernorth and accretive capital deployment, will drive attractive earnings per share growth.
For the full year 2022 outlook, I'd like to first remind you that our outlook assumes the divestiture of our international life accident and supplemental benefits businesses will close in the second quarter of this year.
In total for the company, we expect consolidated adjusted revenues of at least $177 billion, representing growth of approximately 4%, excluding the impact from previously announced divestitures.
We expect full-year consolidated adjusted income from operations to be at least $6.95 billion or at least $22.40 per share, consistent with our prior earnings per share commentary.
We project an expense ratio in the range of 6.9% to 7.3%, further improving upon our operational efficiency and ensuring continued affordable solutions for our clients and customers.
And we expect a consolidated adjusted tax rate in the range of 22% to 22.5%.
I'll now discuss our 2022 outlook for our segments.
For Evernorth, we expect full year 2022 adjusted earnings of approximately $6.1 billion.
This represents growth of about 5% over 2021, within our targeted long-term income growth range, reflecting strong growth in Accredo specialty pharmacy, all while we continue to increase investments in order to drive new innovative solutions to the market.
For Cigna Healthcare, we expect full year 2022 adjusted earnings of approximately $3.9 billion.
This outlook reflects the strength of our value proposition and focused execution in our business, driven by organic customer growth and disciplined pricing in order to expand margin.
Within our U.S. commercial book, organic customer growth is driven by national, middle market and select market segments.
We expect Medicare Advantage customers to be relatively flat compared to 2021, reflecting the competitive backdrop.
And as David shared, we expect a decrease in our individual customers.
We expect the 2022 medical care ratio to be in the range of 82% to 83.5%.
As I noted earlier, this outlook assumes total medical costs will be above baseline in 2022.
Importantly, we are actively managing overall medical costs with a range of affordability actions, including identifying opportunities such as guiding customers to more effective and efficient sites of care.
For example, we focused our Evercore subsidiary on an incorporating site of care review to our existing processes.
These improvements encourage the use of non-hospital settings, which can substantially reduce cost for customers while increasing patient satisfaction.
This action has contributed to results within our commercial book of business, where we are now seeing fewer than 20% of all knee and hip replacements occur in an inpatient hospital setting, down from over 75% in 2019.
We are also continuing to promote preventive care, the targeted use of virtual care through our MDLIVE subsidiary, and access to behavioral services to provide meaningful support to patients and moderate overall medical costs over the longer term.
Through these affordability initiatives and our disciplined pricing actions, we expect to expand margins in 2022, while growing our medical customer base.
Now moving to our capital management position and outlook.
We expect our businesses to continue to drive strong cash flows and returns on capital, even as we increase strategic reinvestment to support long-term growth and innovation.
In 2021, we finished the year with $7.2 billion of cash flow from operations.
Additionally, we returned over $9 billion to shareholders via dividends and share repurchase in 2021, a significant increase from 2020.
And now framing our capital outlook for 2022.
We expect at least $8.25 billion of cash flow from operations, up more than $1 billion from 2021, reflecting the strong capital efficiency of our well-performing business.
This positions us well to continue creating value through accretive capital deployment in line with our strategy and priorities.
We expect to deploy approximately $1.25 billion to capital expenditures, an increase from our 2021 capex levels.
The investments will be heavily focused on technology to drive future growth.
We expect to deploy approximately $1.4 billion to shareholder dividends, reflecting our meaningful quarterly dividend of $1.12 per share, a 12% increase on a per-share basis.
And we expect to use the proceeds from the divestiture of our international life accident and supplemental benefits businesses, primarily for share repurchase.
Our guidance assumes full year 2022 weighted average shares to be in the range of 308 million to 312 million shares.
Year to date, as of February 2, 2022, we have repurchased 2.5 million shares for $581 million.
Our balance sheet and cash flow outlook remains strong, benefiting from our highly efficient service-based orientation that drives strategic flexibility, strong margins and attractive returns on capital.
So now to recap, our full year 2021 consolidated results reflect strong contributions from our focused growth platforms, led by Evernorth.
Our 2022 outlook reflects meaningful contributions from each of our two largest segments, Evernorth and Cigna Healthcare, along with accretive capital deployment.
We are confident in our ability to deliver our 2022 full-year adjusted earnings of at least $22.40 per share, consistent with our prior earnings per share commentary.
Finally, as Ralph noted, we are looking forward to speaking with you in more detail at our upcoming Investor Day in June.
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adjusted income from operations is projected to be at least $6.95 billion in 2022, or at least $22.40 per share.
sees 2022 adjusted revenues at least $177 billion.
sees 2022 medical care ratio 82.0% to 83.5%.
qtrly special items include an after-tax charge of $119 million, or $0.36 per share, related to a strategic plan.
board of directors declared a 12% increase in the quarterly dividend rate, to $1.12 per share.
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Going right into our results.
Our first-quarter adjusted EBITDA of $513 million represented a 79% increase over last quarter, reflecting our first full quarter of results from the former AM USA assets, as well as stronger steel pricing, offset by reduced third-party pellet sales due to the annual maintenance of the Great Lake flocks.
In the Steelmaking segment, we sold 4.1 million net tons of steel products, which included 28% hot rolled, 18% cold-rolled, and 33% coated, with the remaining 21% consisting of stainless, electrical, plate, slab, and rail.
This mix is generally in line with what we expect to see going forward.
Our aggregate average selling price of $900 per ton in Q1 is certainly the low point for the year in our forecast, and is lower than our Q4 2020 average, solely because of the different mix associated with the former AM USA plants.
On the cost side, our performance came in as expected.
Relative to last year, we are seeing decreases in costs for coke and coal, as well as benefits from decreasing scrap use and higher productivity from using our HBI products in-house.
This has been offset by higher prices for scrap, alloys, and natural gas.
We also saw higher labor costs due to increased profit sharing.
DD&A was $217 million for the quarter, and we expect about $840 million on a full-year basis now that purchase price accounting has been further refined.
An important moving piece this year in our cost structure will be iron ore costs.
We certainly benefit on the former AM USA side from transferring pellets at cost.
But during the first and second quarters, we are working through the pellet inventory previously purchased from legacy Cleveland-Cliffs.
These pellets were purchased at a margin prior to the acquisition.
And therefore, the higher cost runs through our income statement in 2021, and the resulting impact is not included in the add-back for inventory step-up.
This short-term anomaly had a negative impact on our first quarter of approximately $50 million and will be a $40 million headwind in Q2.
After that, the impact will be negligible, creating nearly a $100 million EBITDA tailwind going forward in comparison to the first half of 2021.
We experienced the same anomaly in 2020 as a result of the AK acquisition.
As for synergies, we have already identified and set in motion $100 million in cost synergies from the AM USA acquisition, some of which will take effect later this year.
We are well-positioned to reach our target of $150 million of annual run-rate savings by the end of this year for a total of $310 million from the two combined acquisitions.
As far as cash flow, Q1 contains several previously discussed one-time items that will not recur going forward.
As was contemplated in the acquisition of AM USA, we had a significant investment in working capital of nearly $650 million during the quarter, due, first, to the completion of the unwind of the ArcelorMittal AR factoring agreement, as well as other acquisition-related cash impacts.
We are now completely done with this, and receivables have been rebuilt.
Second, we saw a working capital build related to receivables, corresponding to the rising steel price environment.
Also, we made our deferred pension contribution related to the CARES Act of $118 million in January.
With the passage of the most recent stimulus bill and the extended amortization feature, future cash pension contributions will be reduced by an average of $40 million per year over the next seven years.
For the remaining three quarters of this year, we will be generating record levels of free cash flow.
In future years, we expect certain cash outflow items to be lower than in 2021.
Sustaining capex will be approximately $525 million annually.
Interest expense will be lower due to reduced debt.
And pension contributions will also be lower without deferral payments and with the new stimulus benefit.
In addition, working capital impacts will likely revert to neutral over time, unlike the large build we project this year.
Upon releasing our Q4 earnings, we guided to a substantial EBITDA improvement from Q1 to Q2.
And by the end of March, we had enough pricing visibility to disclose a $1.2 billion adjusted EBITDA guide for Q2.
The increase from the first quarter is driven primarily by pricing, offset by higher incentive compensation and profit-sharing and higher raw material pricing for scrap and alloys.
On the liquidity side, we currently have $200 million in cash and $1.6 billion of availability under our current credit facility.
Our ABL debt balance is currently $1.6 billion, and we expect to have this paid off by the end of the year.
Our pay down of this instrument will come penalty-free, and every dollar that has reduced in ABL debt will be added to our liquidity.
In closing, we find ourselves well-positioned to take advantage of a healthy steel market and also take care of a significant portion of our debt balance in very short order.
Based on what we are seeing in the market, we believe our estimates supporting $4 billion of adjusted EBITDA for the year are conservative relative to today's forward curve.
And it was an immensely successful quarter for our integration, culture change, and clearly, our profitability.
Our attitude toward commercial and steel pricing is the main reason behind the massive numbers we are showing for the quarter and guiding for the balance of the year, including $513 million of EBITDA in Q1, $1.2 billion EBITDA next quarter, and $4 billion EBITDA for 2021.
The steel industry is capital-intensive and return on invested capital is necessary.
If we lose track of that, we would not be able to address issues like equipment reliability, workplace safety, or the environment.
We are not greedy.
That's why steel prices are where they are and that will continue going forward.
Right now, the America consumers are consuming, and they are consuming a lot.
The stimulus money provided to the majority of the population is being redirected right back into the economy, and that's great for flat-rolled steel producers like Cleveland-Cliffs.
This money is being spent on consumer goods like HVAC and appliance and cars, evidenced by the skyrocketing AUTOSAR in March.
The so-called experts that long predict the demise of the domestic steel industry have been proven completely wrong.
When Cleveland-Cliffs bought AK Steel and AM USA or when the COVID recovery began, they had an easier window of opportunity to fix their failed thesis.
Unfortunately, their addiction to negativity is apparently the only thing that they care about.
These folks just don't want to see our industry thrive, and they clearly don't care about the well-paying middle-class jobs we generate and sustain in the United States.
For the record, from our proximate years, the median yearly pay of our 25,000 Cleveland-Cliffs employees is $102,000.
And we are hiring because we're growing.
Make no mistake, we are adding jobs.
Since December 9, 2020, we have already added 710 new employees to our workforce.
As we always do at Cleveland-Cliffs, we are putting our money where our mouth is, and bringing back the America that we love, with a vibrant manufacturing sector, a thriving middle class, and with opportunities for all people that believe in education and hard work.
The main factor supporting this new way of doing the steel business are the following.
Prior to our acquisitions of AK Steel and AM USA, they were both buying iron ore pellets from Cleveland-Cliffs under take-or-pay type of contracts.
As a result, their top concern was filling up their steel order book so they could satisfy their purchase requirements with us.
And in many cases, that involved being aggressive on pricing their end product so they could move material.
We and the business we acquired are no longer burdened by this, which leads me to number two, a more disciplined supply approach.
As I have stated in the past, we can be flexible with our production and can walk away from bad deals, automotive, contract, spot, or otherwise, much more easily.
This industry has been plagued in the past by volume for volume's sake.
But with our transformative acquisitions, we have all started to see rationality in the marketplace.
And don't forget, the U.S. dominates the world in environmental performance.
Of all the world CO2 emissions from the steel industry, the U.S. comprises just 2%, while China is responsible for 64%.
We have also the lowest CO2 emissions per ton of steel produced among the nine largest steelmaking nations, due to both the prevalence of EAF production and the massive use of pellets in blast furnaces.
This leads me to my final factor, the one that will drive mid-cycle, hot-rolled coil pricing higher for the long term, the scarcity of prime scrap.
EAFs make up more than 70% of steel production in our country.
This U.S. reality is unique among all major steel-making countries.
EAFs have long taking advantage of the large pool of scrap here in our country.
However, with all the new capacity coming from the EAF side of the business, their scrap feedstock has become stretched, although thin.
In order to make flat-rolled products in EAFs, you need prime scrap and metallics, both of which actually originate from the integrated rock.
On top of that, manufacturers have become more efficient at processing high-grade steel, generating less prime scrap to be sold back to the system.
The United States is a net exporter of scrap, but it is also a net importer of prime scrap.
Combine that with China's growing needs for imported scrap, which will outpace their own generation in the near term, and the U.S. EAFs have a big problem.
Obsolete and lower grades of scrap will likely be OK, as higher prices incentivize collection.
But that's not the case for prime scrap.
Lower-grade scrap is good for rebar, but it's not good or not enough for the production of more sophisticated flat-roll steel products.
This scarcity points to significantly higher prices for scrap.
Meanwhile, we at Cleveland-Cliffs, will continue to enjoy the steady cost structure of our iron feedstock, our own 100% internally sourced pellets, with decades of iron ore reserves ahead, and our in-house production of HBI, fed by our online and pellet plant.
We formulated this view in 2016, and that has been the driving force behind our strategy for the past five years, including the construction of our HBI plant and our two transformational acquisitions executed last year.
It is actually interesting to see other companies get into the same conclusion five years later.
At the time, Cleveland-Cliffs has already started to enjoy the benefits of our investments of the past years.
Our direct reduction plan has had a remarkable past few months since the start-up in December of 2020 and has already exceeded our expectations thus far on HBI production and shipments.
We produced 120,000 tons of recast in the month of March and expect to reach our annual run rate of 1.9 million tons this quarter.
While we have already shipped some HBI tonnage to select outside clients and at a very good prices, we have thus far used most of the product internally at our own EAFs, blast furnaces, and BOFs, as planned.
Operational results have been above our own expectations in all times of internal usage of our HBI.
Particularly at our EAFs, HBI currently makes up between 20% and 30% of their melt.
More importantly, our HBI has effectively eliminated our needs to buy prime scrap.
We only need to buy lower grades at this point, substantially lowering our cost structure.
It has also lowered our greenhouse gas emissions and improved our iron and chrome yields.
The original intention for the Toledo direct reduction plant when Cleveland-Cliffs was just an iron company was to exclusively sell HBI to third parties.
But that dynamic has changed with our two acquisitions of last year.
Given our expectations for the scrap market, our HBI is an incredibly important Cleveland-Cliffs internal resource and differentiating factor, both now and going forward.
This is why I'm happy we did not sign long-term contracts to supply HBI to third parties.
I did not need them to build the plant.
I don't have them now, and I don't want long-term supply contracts going forward.
For the record, the consistent performance we get out of our HBI in all of our plants, both in quality and environmental, is one of the most positive factors differentiating Cleveland-Cliffs from the rest of our competitors, both integrated and mini-mills.
On the steel operations side, things have been progressing nicely.
Our Middletown outage was a success.
We completed the blast furnace repair in less than 14 days.
And the BOF vessel maintenance was finished ahead of schedule, and we do not have any major outages scheduled in Q2.
We are focused on getting steel out of the door.
Despite all we hear about supply shortage of electronic parts and other components in automotive, we really have not seen a huge impact on volumes to this end market.
We have been running our coating lines at full capacity in response to outstanding demand and are restarting our Columbus Coatings galvanizing line.
That will increase our output of galvanized products starting in this second quarter and will help our clients take care of their own high demand.
For the small amount of automotive tonnage that has been deferred, we have been able to divert that substrate to higher-margin customers linked to the spot market.
We completed all of our April 1 automotive contract renewals with nice price increases and plan to continue to see significant improvement in these margins going forward.
All of our actions support immense cash flow generation for this year and beyond.
And that cash will be used to pay down debt.
Under our latest forecast, we expect to generate a record level of free cash flow in the last nine months of 2021, which will put us at a figure of less than 1 times EBITDA leverage by the end of the year.
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compname reports first-quarter 2021 results and increases guidance for full-year 2021 adjusted ebitda to $4 billion.
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Our second-quarter numbers for revenue, net income, and EBITDA were all quarterly records.
They clearly demonstrate our operational and commercial success in integrating the two acquisitions into Cleveland-Cliffs as well as a sustainable steel environment, supported by strong and resilient demand for our products.
This being said, our Q2 record numbers: revenue of 5 billion; net income of 795 million; and adjusted EBITDA of 1.4 billion, should not be our all-time records for long.
With the lagged and fixed pricing mechanisms we have in place with our customers, we have enough visibility to be confident that these records should be broken again here in the third quarter.
Drilling down specifically on our adjusted EBITDA, the 1.4 billion performance represented a 165% increase over the past quarter, primarily due to increased steel pricing fixed-price contract improvements, favorable product mix, and higher volumes.
Unlike most of the American steel industry, we have been relatively well shielded from inflationary forces thus far due to our self-sufficiency in raw materials, namely pellets, and HBI.
More specifically, our overall cost per ton barely moved compared to the first quarter.
In the Steelmaking segment, we sold 4.2 million net tons of steel products, which included 33% hot-rolled, 17% cold rolled, and 30% coated, with the remaining 20% consisting of stainless, electrical, plate, slab, and rail.
Due to lighter automotive demand pool related to the chip shortage, we were able to sell more tons of higher-margin material into the spot market.
Direct automotive shipments were about 1.2 million tons during the quarter, about 300,000 tons less than what we anticipated back in March.
This contributed to an inventory build of about $300 million during Q2, which, along with rising receivables due to rising prices, produced another working capital build during the second quarter.
Our free cash flow generation will certainly be further increased in the third quarter.
We expect to generate 1.4 billion in cash from our expected 1.8 billion in adjusted EBITDA for the third quarter.
These numbers result from continued rise in prices on our HRC linked contracts and spot sales, offset by higher employee-related costs and the planned outage at our largest blast furnace, Indiana Harbor No.
Furthermore, we are increasing our full-year adjusted EBITDA guidance to $5.5 billion.
Our free cash flow expectation still includes minimal federal cash tax disbursement as a result of our NOL position.
Given our immense profitability so far this year, we have been able to effectively utilize our sizable NOL balance, and we'll continue to utilize it for the rest of the year.
With these NOLs rapidly being used, we expect to become a federal cash taxpayer again at some point either later this year or early next year.
Our main priority with this free cash flow continues to be the paydown of debt.
The level of free cash flow we are expecting has created a generational opportunity to completely derisk our balance sheet, and we are taking full advantage.
In the second quarter, we made open market bond repurchases and completely redeemed the remaining 400 million of our 2025 unsecured notes, the only bond we had that was callable this year.
Our debt-to-cap ratio is currently at a nine-year low.
And we have already repaid another 455 million in debt during just the first 20 days of July.
As the year progresses and into next year, we will be rapidly and methodically reducing our debt balance, and we expect to reach net debt zero sometime next year.
With that, I'll turn it to Lourenco.
The best way to understand the new Cleveland-Cliffs is by comparing Q2 results with Q1.
Our revenue line increased by $1 billion and our cost of goods sold increased by just $100 million.
The seamless and complete integration of both AK Steel and ArcelorMittal USA into Cleveland-Cliffs has generated a new and very efficient business model, geared toward value creation.
Demand for steel is very strong across all sectors, and strong demand supports strong prices.
Q4 2020 was supposed to be the peak for steel prices, then Q1 2021, and then again in Q2.
Well, we are in Q3, and the reality is demand is relentless.
Most of our customers are experiencing record profits and learning that higher prices are good for pretty much everyone in the supply chain.
Actually, some of the customers who were complaining earlier this year about rising steel prices then turned around and decided to accept the reality.
They cut deals with Cleveland-Cliffs at that time, and are now just plain happy.
Others probably will be unhappy for a long time.
Also, as new electric arc furnace capacity continues to be brought to operation in the United States and abroad, the notion that prime scrap is precious metal will be better understood.
Iron ore fundamentals are strong as well, keeping the price of pig iron imported by the mini views elevated, and also pushing up the pricing of steel offered by foreign sources.
Russia is restricting exports of ferrous materials, including pig iron, of which they are the largest exporter of to the United States.
China continues to say that they want to cut emissions, which they can do by either cutting steel production to reduce sinter usage or using more scrap or both.
With all that, the trend on the price of prime scrap is also upward.
Separately, investments toward decarbonization will need ROI, return on investment, unless you operate in Europe, in Japan, or in Canada.
Steel companies in these countries and continent are being awarded general subsidies and free money, like the grants.
Canadian and European steel producers are so happy to advertise as they get their gifts and handouts from their respective governments.
That's another compelling reason why imports need to be held in check, as other countries take advantage of a totally uneven playing field.
With their much worse environmental performance than ours in major government subsidies that we don't get here in the United States.
China is not our only problem, our so-called friends are bad, too.
While all of our relevant Q2 figures represent company records revenue: net income, adjusted EBITDA, I would add, we haven't reached our full potential yet.
Due to previously agreed upon sales contracts, so far this year, we have sold a significant chunk of our volume well below price levels that would make us comfortable.
Our most important commercial priority through the end of this year will be to improve these contracts.
We know the real value we provide to the clients, including, but not limited to, our ability to manage complex just-in-time requirements in several different highly specified products.
We also know the unique technological capabilities that we have and the limitations of others in the steel industry that cannot match what we do, particularly at the massive scale that we do.
Simply stated, it's time to be awarded a better return on our capital invested to serve these clients, and we are well underway to achieve that.
Being the largest supplier of steel by a lot to the automotive industry, we are obviously affected by the supply chain issues they have experienced, all related to things other than steel.
Nevertheless, our Q2 results were actually better than our guidance, among other reasons, because we were able to take advantage of the reduced demand from these customers and managed to divert automotive volume to spot buyers or to other contract clients willing to pay market-level prices.
When stated like that, it sounds simple.
But reorganizing both the melt schedules and deliveries of these materials was a challenge that our team did a great job overcoming during the quarter.
Even with all the difficulties in finding available rail cars, trucks, and truck drivers during the quarter, we were still able to increase our shipment volume in comparison to Q1.
One thing that should not be holding up anything any longer is COVID-19.
Brilliant scientists have developed not one, but several truly groundbreaking vaccines that would stop the virus and its tracks and any current variants.
But we need enough people taking the vaccines.
With the safety of our workforce always a top priority.
earlier this month, we instituted a companywide vaccination bonus program that offers a cash bonus of $1,500 to each vaccinated employee if the level of vaccination of their working sites achieved 75%.
If the level of vaccination of the site achieves 85%, the cash bonus paid to each employee of the site doubles to $3,000.
Upon announcement of the program, we saw an immediate uptick in vaccination rates.
And some of the locations are already at the first threshold, with two locations already at a second threshold of 85%.
Protection from the virus is just as important as any other safety mandates we have in any of our locations, and we are willing to spend real money to ensure each of our facilities reach herd immunity.
In order to meet current market demand, our assets need to be well staffed, and well maintained.
This process involves preplanned maintenance outages, including the one taking place at Indiana Harbor later in this quarter from September 1st to October 15th.
7 is the largest blast furnace in North America, and for reference, produced 33% more hot metal per day than our two blast furnaces at Cleveland works combined.
The outage includes repair to two BOF converters in the steel shop and a partial reline in several upgrades to the blast furnace.
Some of these upgrades are related to our ongoing work toward decarbonization, such as further enhancements to our ability to use massive amounts of both HPI SP stock and natural gas as supplemental reduction at Indiana Harbor No.
Another success story of the past quarter is our Toledo Direct Reduction plant.
We reached our nominal capacity within six months of start-up.
And thus far in July, we are producing at a 2.1 million tons annualized rate, well above nameplate of 1.9 million tons per year.
Our timing could not be better.
Prime scrap is scarce.
And every day the price of scrap goes up, our cost savings from HBI becomes more significant.
On top of that, we have actually used the vast majority of our internally consumed HBI in our blast furnaces, enhancing hot metal output, and allowing us to capture additional margin on incremental steel tonnage produced and sold to clients.
Along with the productivity benefits, this action alone reduced our implied carbon emissions by 163,000 tons during the quarter.
Direct reduction and degrade pets are critical to the future evolution of a clean and environmentally friendly steel industry.
Cleveland-Cliffs sees decarbonization as part of our license to continue to exist.
As you can see in our recently published sustainability report, we are well on our way to achieving our targets through the combination of natural gas usage, HBI production and internal usage, and carbon capture.
There's a lot of talk about hydrogen as a reduction in Europe, with little recognition that we already use hydrogen in the United States through the use of natural gas.
Natural gas composition is 95% CH4, methane, and 4% C2H6, ethane.
Natural gas is used in our blast furnaces as a partial replacement for coke.
That means we emit good old H20 when we reduce our iron ore.
And CO2 ambitions are cut by more than half when compared to reduction exclusively by coke or coke plus PCI.
Also, our direct reduction plant uses 100% of natural gas as a reduction.
The total amount of natural gas, we currently use in our eight blast furnaces and in our direct reduction plant eliminates the need for 1.5 million tons of coke per year, the equivalent of two coke batteries.
And we continue to explore and increase the use of natural gas throughout the entire footprint.
Actually, our direct reduction plant was designed and built to be able to use up to 70% hydrogen.
But in order to make hydrogen a viable reduction, serious cost improvements and breakthrough technical developments are still needed.
Europe does not have abundant natural gas, other than in Russia.
So they have embraced the hydrogen route, even with the current uncertainty surrounding the economical use of hydrogen.
That might not take them anywhere as far as emissions control, but is actually a great shortcut for free money and more subsidies from government to companies.
And we all know how these things end.
Replacing blast furnaces with AIF is not a solution either.
There are technical reasons.
No major steelmaking nation runs entirely on EAFs.
When producing flat-rolled steels, EAFs need a significant amount of virgin material, like pig iron, prime scrap, DRI, HBI, and even oxygen injection just to try to mimic the blast furnace BOF route.
In reality, even here in the United States, soon to achieve 75 participation of EAFs, we may be near a peak, particularly in further investments in direct reduction are not made.
Just don't count on Cleveland-Cliffs for that.
This ship has sailed when we acquired ArceloMittal USA and AK Steel, and successfully integrated both into a single unit company named Cleveland-Cliffs.
At this point, we are very comfortable using our degrade pellets to exclusively supply our plant in Toledo our blast furnace great pellets to supply our own blast furnaces.
To wrap up, Cleveland-Cliffs is doing well, actually, very well.
As of today, our leverage is already below one-time EBITDA.
And we expect to be at net debt zero sometimes next year.
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expects third-quarter 2021 adjusted ebitda of about $1.8 billion and free cash flow generation of $1.4 billion.
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So many of those listening today know him already.
In his previous role as Senior Vice President of Finance and Treasurer here at Cleveland-Cliffs, Celso was instrumental to our business and financial transformation.
Over the past five years, he has led all of our capital structure efforts, being the key person behind the execution and financing for our transformational acquisitions and managed our liquidity through the pandemic.
Prior to Cliffs, Celso had a very successful career as an investment banker, first at Jefferies and then at Deutsche Bank.
Also, if you couldn't tell by his last name, Celso is my son.
During the last several years, Keith Koci and I have been preparing Celso for this job.
With Keith now in charge of our new business unit as president of Cleveland-Cliffs Services, we could not have a better or more prepared professional to lead our financial organization.
I am humbled by the opportunity to serve as Cliffs' CFO, fully aware of not only our rich 174-year legacy, but also our position of immense influence as the largest flat-rolled steel producer in the United States.
I also fully expect that given my family name and the high standards set by our CEO, the expectations for me will be even greater than for anyone else in this seat.
I am prepared to deliver.
My experience here at Cliffs over the past five years has taught me that strategic and financial opportunities exist at all points in the cycle.
My priorities as CFO are simple: one, allocate capital in a way that strengthens our business; two, maintain and enhance our financial flexibility; three, deleverage the capital structure; four, evaluate and execute opportunistic M&A and capital market transactions, always with a focus on long-term shareholder returns; and five, continue our five-year track record of share outperformance relative to our peer group and the broader market.
With those introductory remarks aside, I will jump right into our third-quarter results.
We reported another quarter of record revenues of $6 billion, record net income of $1.3 billion and record adjusted EBITDA of over $1.9 billion, ahead of the guidance we recently set of $1.8 billion.
Our 42% quarter-over-quarter growth in adjusted EBITDA was primarily driven by continued price increases on our index linked and spot shipments.
These sharp increases on the revenue side were only partially offset by gradual increases on the cost side, including for labor, natural gas, and additional repairs and maintenance, most notably the reline of Indiana Harbor No.
7, the largest blast furnace in North America.
And even though it was clearly a one timer, we did not add back to EBITDA, the vaccination bonus payment of $45 million that was awarded and paid out to our workforce under our very successful vaccination incentive bonus program, which resulted in over 75% of our workforce fully vaccinated against COVID-19.
In the Steelmaking segment, we sold 4.2 million net tons of steel products with a mix of 32% hot-rolled, 18% cold rolled and 31% coated steel, with the remaining 19% consisting of stainless, electrical, plate, slab, and rail.
Our automotive percentage of revenue was 20% compared to 33% just two quarters ago, clearly reflecting the reduced volumes and the legacy annual prices from that sector.
Both of which should dramatically improve next year.
We expect the trends on pricing and costs in Q3 to carry over into Q4, with higher prices from both index-linked contracts and some of our repriced automotive contracts, offset by similar cost impacts we experienced in Q3.
Shipments will likely be lighter in Q4 due primarily to seasonality and lower automotive shipments.
Offsetting this, we will be moving up to the fourth quarter, some planned maintenance outages originally scheduled for next year, including the Dearborn hot end and both blast furnaces at Burns Harbor, along with a few other associated rolling and finishing facilities.
These outages are being accelerated to this year in anticipation of a strong automotive recovery in 2022.
All these events considered, our fourth quarter production should be reduced by approximately 300,000 net tons compared to the third quarter.
Our free cash flow generation came in at $1.3 billion for the quarter, slightly lower than our original guidance due to slow demand pull from automotive, leaving more inventory to close out the quarter than we expected.
The remaining outage period at IH7 as well as the additional outages we scheduled for the fourth quarter should allow us to reduce these inventory levels during Q4.
This free cash flow generated during Q3 was returned entirely to shareholders in the form of a stock buyback, executed via the complete redemption of our $58 million common share equivalent preferred stock.
With only one quarter's worth of free cash flow, we completely redeemed our preferred shares.
I will note that because of the weighted average calculation and the fact that the prefs were outstanding during a portion of Q3, the full $58 million share reduction is not baked into our Q3 earnings per share just yet, we will see a further reduction of diluted share count in the fourth quarter.
With the prefs now completely out of the way, we have resumed our aggressive debt reduction activities.
In only the last three weeks since the end of Q3, we have already generated approximately $500 million in free cash flow and have allocated all of it toward debt repayment under the ABL.
Upon closing of the FPT acquisition next month, all excess free cash flow will continue to be allocated toward further debt reduction.
By next quarter, our LTM adjusted EBITDA should exceed our overall net debt balance, resulting in less than one turn of overall net leverage for the foreseeable future at any reasonable HRC pricing assumption going forward.
Because of our strong profitability this year, at some point in the fourth quarter, we will have utilized the majority of our tax NOL balance, leading to an expected Q4 cash tax rate of around 10%.
Prior to the acquisitions of AK Steel and AM USA, we once expected to be utilizing these NOLs for several more years, but the significantly higher profit generation following the acquisitions will result in the consumption of the majority of the $2.5 billion NOL balance within a year of closing the December 2020 transaction.
Even with the additional cash tax outflow and payments related to the CARES Act FICA deferrals from last year to this year, free cash flow should remain remarkably healthy in Q4.
The $775 million price of the previously announced acquisition of FPT is equivalent to less than two months of our free cash flow generation.
Wrapping up, the financial position of the company is on stronger footing today than it has been during my entire time here at Cliffs and the trend should continue into Q4 and 2022.
The fixed price contract business we have with high-end clients, such as the automotive OEMs, gives us significant downside protection if spot prices trend lower.
Therefore, even under the current bearish futures curve for HRC, our average selling price should be much higher next year than it has been this year, leading to the expectation of another year of outstanding EBITDA, cash flow generation and debt reduction in 2022.
Very few companies can show the magnitude of growth Cleveland-Cliffs has delivered during the last couple of years.
We were a $2 billion revenue company in 2019, became a $5.3 billion revenue company in 2020 and expected to be a $20 billion-plus company in 2021.
All this growth was achieved preserving and enhancing our profitability as demonstrated by our Q3 numbers of $1.9 billion of adjusted EBITDA and $6 billion in revenues for an EBITDA margin of 32%.
These numbers have gone primarily from the 55% of our business that is linked to an index price with a smaller contribution from the fixed price contracts that were signed before the market price recovery of last year.
In the fourth quarter, this will begin to change.
And even more so, you see next year, when the bulk of our annual fixed contracts for automotive as well as appliances, stainless, electrical use plate and tin plate all reprice at significantly higher levels.
That should protect our profitability into next year, even assuming spot prices go down next year.
This being said, we do not believe we will see still spot prices returning back to historical low levels.
And the main reason for that is prime scrap.
Prime scrap is what electric -- furnace mills, old ones or brand-new, need to produce flat-rolled steel.
We have seen a looming shortage of this type of scrap coming for several years, which partially motivated our $1 billion investment in our direct reduction plant four years ago.
We were planning to supply HBI to EAF mini mills.
And that was in the past, but not anymore.
At this time and going forward, we also plan to use more prime scrap ourselves in our BOFs.
That will allow us to stretch our hot metal without building new production capacity.
Building new capacity is a common mistake the steel industry insists in making time and time again.
Cleveland-Cliffs is different, and we are not going to add capacity ourselves, but we are definitely seeing what others do, and we act accordingly.
With that in mind, a few days ago, we announced the acquisition of FPT.
While the majority of scrap companies we looked at had a prime scrap mix of 10%, 15%, FPT stood out with an outsized 50% of prime scrap in the mix.
FPT is actually one of the largest processors of prime scrap in the country, representing 15% of the entire merchant market in the United States.
Prime scrap is a byproduct of manufacturing, including automotive.
And Cleveland-Cliffs is the largest supplier of steel to this automotive and other flat-rolled consuming manufacturers.
As such, we can offer a compelling proposition for their scrap uptake, keeping the life cycle of our steel in a closed loop between Cleveland-Cliffs and the OEM.
Furthermore, the main theme for the steel industry is decarbonization and melting clean, low impurity scrap is a good way to reduce carbon emissions.
That applies to both EAFs and BOFs.
The BOF is often overlooked as a user of scrap.
But in our footprint, it's actually where we consume the most.
The use of higher amounts of scrap in the BOF boosts liquid steel output for the same amount of hot metal, which is what we call the liquid pig iron from the blast furnace.
So the more scrap used in the BOF, the less coke needed in the blast furnace per ton of crude steel produced.
With ample access to our own prime scrap, we can optimize our productivity with a higher scrap charge, while significantly reducing our carbon emissions.
On top of that, during the last 50 years, the supply of prime scrap in the United States has been steadily shrinking.
We expect that [Inaudible] trends to continue as yields continue to improve, and unfortunately, China continues to dominate manufacturing.
Finally, all of the new flat-rolled capacity coming online in the United States is from the EAF side, which means that demand for prime scrap and metallics will continue to increase.
That is very conservatively another nine million tons or 40% growth of demand for these products over the next four years.
With our decision to use our HBI internally at Cleveland-Cliffs and primarily in our blast furnaces, there is a zero response in supply to this massive growth in demand for prime scrap and metallics coming from the EAFs.
Pig iron may be the most likely alternative but they still choose emissions that comes attached to pig iron, whether imported or mainly in North America, effectively create a negative impact to the Scope 3 emissions associated to these EAFs.
In that regard, we fully expect that in a not-so-distant future, the Scope 3 emissions will have to be reported as much as our Scope 1 and 2 already are reported today.
That would create a level playing field for all steelmakers integrated and EAFs.
Moving forward, this is a good opportunity to remind everyone that no other steel company in North America has more capabilities in modern ones, by the way, than Cleveland Cliffs when it comes to producing flat-rolled steel.
That's particularly true regarding automotive.
People tend to confuse old plant names like Indiana Harbor, Cleveland Works or Burns Harbor with old plants.
In fact, old plant names actually carry pretty modern state-of-the-art equipment.
For example, our hot-dipped galvanizing line at Rockport Works was built in the '90s, and it's 80 inches wide and that is six foot, eight inches wide, or 2,032 millimeters before a metric system, more than two meters wide.
There is no other facility on the continent that can produce what we make there.
The same is true for the six footers at Tek and Kote in New Carlisle, Indiana and Columbus, Ohio.
Also, our advanced high strength steel capabilities at Cleveland Works are second to none, and the automotive OEMs know that.
Our pickling line tandem cold mill and galvanizing line in Dearborn, Michigan, by the way, another six footer, specialized in exposed panels, were both built in 2011.
One more time, Dearborn Works was built by Ford Motor Company in the early part of the 20th century.
But the PLTCM and the hot-dipped galvanizing line are only 10 years old.
Our level of technological sophistication and our ability to produce all kinds of automotive flat-rolled products, including stainless steel, are the reasons why Cleveland-Cliffs is by far the biggest supplier of automotive still in this country.
A couple of our competitors will be spending billions of dollars and working very hard to build capacity during the next three years.
We don't need to because we already have the capabilities we need.
That's why Cleveland-Cliffs supplies 2.5 times more steel to the automotive industry than the second largest supplier or more than the second plus the third combined.
Another important accomplishment during the quarter was the consistent performance of our direct reduction plant in Toledo.
The plant continues to operate above nominal capacity and to exceed our expectations, not only on production but also in quality and cost.
Case in point, our all-in cash cost of HBI in Q3 was $187 per net ton, a number much better than the cost projected when we first approved the construction of the plant a few years ago.
This figure is also much better than the price our competitors pay for both prime scrap and imported pig iron.
Also differently from our original plan, HBI sales to outside EAF mills are not significant and maybe discontinue completely very soon.
We actually have already decided to use the majority of our HBI in our blast furnaces, not even in our own EAFs.
That allows us to improve better cost and productivity while improving our coke rates and reducing our CO2 emissions.
Also, as a consequence of our HBI using our blast furnaces, we have already idled the coke batteries at Middletown Works and that coke is not needed at this time.
Another operational change, we started to implement in the third quarter involves our Minorca mine and pellet plant which we acquired as part of the ArcelorMittal USA acquisition.
Based on our tasks, we will soon be shifting our DR-grade pellet production away from Northshore and into Minorca, where we will not have to deal with the unreasonable royalty structure at Northshore.
As we plan to no longer sell pellets to third parties in the coming years, Northshore will become a swing operation, which we will keep idle every time we decided to do so.
In any event, we will continue to be able to feed our Toledo plant with a consistent feed of DR-grade pellets but from Minorca and not from Northshore.
As also explained earlier, we continue to generate plenty of cash and should see a meaningful reduction in debt during the fourth quarter, even after paying for the FPT acquisition.
Based on our expected EBITDA for this year, our 2021 full-year leverage is already at a very comfortable level of less than one time EBITDA.
With the new sales contracts we have already signed, our ability to continue to pay down debt is even stronger than what we announced last quarter.
The $45 million that we paid in vaccination bonus this quarter was by far our best use of cash.
And we are pleased that we reached above 75% vaccination rate across our entire footprint, beating by a large margin the percentage of vaccinated local population in all communities we operate.
We are keeping our workforce safe, healthy and compensating them to do so.
Soon, we look forward to welcoming another 600 Cliffs employees from the FPT acquisition.
We can't wait to bring them into our company and our way of doing business.
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believe that our average sales price next year should be higher than in 2021.
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Life at Cleveland-Cliffs has been intense, and we have a number of developments to discuss today.
We completed the acquisition of ArcelorMittal USA on December 9, 2020.
And a couple of weeks earlier, we completed the construction and begun operating our direct reduction plant in Toledo, Ohio.
We have also, one more time, with our financial expertise to good use and took advantage of opportunities presented by the capital markets to improve our balance sheet.
And last but not least, we have recently announced our public commitment to aggressively reduce our greenhouse gas emissions 25% by 2030.
I will begin with the most transformational theme, the acquisition of ArcelorMittal USA including the totality of INtech and INCoats, which ArcelorMittal previously shared ownership with Nippon Steel.
The very first point I would like to make is the most important part of the acquisition, and that is the people that are now working for Cleveland-Cliffs.
I could not be more pleased with the buy-in we have received from the workforce previously working for ArcelorMittal.
Not just from the leadership team, but also from the employees at the shop floor.
If there is a single reason why we are doing so well as we integrate the new assets to our existing footprint, that is the buy-in from these new Cleveland-Cliffs employees.
That came also with the normal support and help coming from the employees that were it does before, included the ones that joining Cliffs from AK Steel.
It is fair to say that the entire workforce and that includes our union partners, all recognize that Cleveland-Cliffs' unique business model is now the envy of the steel industry, and they seem to be proud of that.
We have proof ideas without strategy are nothing.
And strategy without execution is irrelevant.
But one can only execute if the people involved believe and buy in.
Our great workforce, integrated and unified under a common strategy and disciplined execution, is the reason why we have been so successful.
Our competitive advantage is also predicated on a few things.
We operate the entire production flow from the extraction of iron ore out of the ground all the way to manufacturing of complex auto parts and components.
Said another way, Cleveland-Cliffs has reinvented the meaning of the word integrated, as in integrated steel mill.
The word now includes mines, pellet plants, direct reduction, blast furnaces, DOFs DAFs, ALDs, hot strip mills, plate mill, cold rolling mills, electrolytic thinning lines hot-dip galvanizing lines, electro galvanizing lines, cold and hot stamping, precision welding, laser manufacturing, and complex tooling.
All these resources give Cleveland-Cliffs full control on costs and quality, and results includes having a tangible competitive advantage over our competitors.
Also, as we process in our downstream facilities is still produced by other companies, we have a window into what others are actually capable or not capable to do in automotive.
Such insights was a determinant factor in guiding our decision to acquire AM USA.
The assets we acquired from AM USA are complementary to the ones we already had from AK Steel, and that will save us from spending a significant amount in capex to make the AK Steel assets able to produce certain grades that we can produce in Indiana Harbor or Cleveland works.
For the ones I would like to talk about who is gaining market share from him in the steel business, let me remind you one thing.
One year ago, Cleveland-Cliffs was producing fairly zero tons of steel.
And we are now, one year later, the largest flat-rolled steel company in North America.
That is a pretty sizable gain in market share, I believe.
Even more importantly, in comparing what we have at Cleveland-Cliffs with what we see from others, we feel extremely comfortable that our leadership position in automotive is very solid.
The acquisition of AM USA elevated our participation in automotive to five million tons per year.
On top of that, we also supply 1.5 million tons of automotive-grade blast to ArcelorMittal Nippon Steel in Calvert, Alabama.
Even with increasing tons from 3 million to 5 million, we actually reduced our percentage of participation in the auto sector from 70% as AK Steel stand-alone to 40% as the combined Cleveland-Cliffs, allowing us to benefit faster from higher market prices for steel.
We also supply 100% of our iron ore needs in-house, and that is extremely important.
The steelmaking assets we acquired both from AM USA and from AK might have been historically at a competitive disadvantage on that regard, due to having to purchase pellets from us.
But now, the advantage is kept all within Cleveland-Cliffs.
Another point to consider.
Differently from the scrap-based nonunion shops, we do not pay our employees based on tons produced.
Unlike these other steel producers, our business model does not prioritize the production of tons.
And we are not in the pursuit of capacity utilization either.
We prioritize value over volume.
We prioritize delivering on time, and we accommodate the demands of our clients, particularly automotive clients.
We, in 2021, are applying to the newly acquired assets the same methodology we applied to AK Steel in 2020.
And that will bring the new assets to the same high level of delivery performance we have established at AK Steel since we implemented our way of doing business last year.
Our clients know that and appreciate the changes and improvements we have been implementing.
Our asset optimization process is off to a great start as well.
We have already started moving slabs and coils between the former AK former AM facilities to reduce logistics costs and to improve our customers' delivery requirements.
This material movement continues to be optimized and we should increase over time.
With that and several other initiatives, we are well on the way to reach our synergy target of $150 million by the end of this year.
Next, on to our Toledo plant.
We are delighted to have completed construction of the most modern direct reduction plant in the world and to begin production of HBI late last year.
Those who have been following us are well aware of the value proposition this product brings to both Cleveland-Cliffs and to the entire industry.
Our natural gas-based HBI is not only a cost-competitive premium alternative to imported [Inaudible] and scrap but will also reduce Scope two greenhouse gas emissions in our industry as a whole.
Additionally, once hydrogen becomes commercially available, our plant is already capable of using up to 30% of hydrogen as a partial replacement for natural gas with no equipment modification needs, and up to 70% with minor modifications, which would even further reduce emissions from the baseline.
We are progressing through our planned ramp-up period, steering through a cold winter and making the appropriate adjustments to bring the plant up to its full production level by the second quarter.
We are currently making HBI exclusively for our own internal use, and we will start to ship product to third-party customers later in March.
The timing of the start-up of HBI plant is extraordinarily positive for us with the obvious scarcity of domestic prime scrap in the marketplace.
This scarcity of scrap should only grow as new EAFs start up in the United States, and we will have more bias for the same scrap.
Good for our HBI and good for Cleveland-Cliffs.
We are also benefiting from a favorable steel price environment.
This is particularly true since we acquired AM USA.
This latter acquisition has given us more exposure to spot HRC prices.
Then when we only owned AK Steel, with a case outsized percentage of fixed price automotive contract sales in the product mix.
With our very relevant position as a player in the newly consolidated U.S. domestic market, we are taking a disciplined approach to supply.
We will continue to manage our customer needs and will not restart capacity on a whim just to add tonnage to the spot market.
That would not be good for anyone, including Cliffs' business and our workforce.
As I said, we don't pay our people based on tons produced with the practice that has impacted this industry.
We let our order book guide our production levels.
Right now, the order book is in a good place, particularly for consumer goods, as well as from stainless steel clients and service centers in general.
Demand from automotive remains strong, and auto OEMs continue to struggle to keep up with resilient consumer demand.
So far, we have seen only minor short-term demand impact from a widely publicized cheap shortage, all of which, as we have been told by our automotive clients, will be made up for during the year.
In the meantime, we have been selling more steel to select service centers and manufacturing clients outside the automotive sector, enhancing our presence with these clients.
This is actually a very positive demand development for these select clients.
Because they are increasing their business with Cleveland-Cliffs, a company that is very accustomed with producing high-quality steel and delivering on time, and also very good for us because we are accelerating the benefit from higher steel market prices ahead of annual contract renewals with automotive clients.
The value over volume philosophy also guides our near-term production decisions.
As has been publicized, we will be taking our Middletown facility down for a 45-day maintenance outage to do some work inside the blast furnace, but not a full reliance.
In order to continue to meet our strong customer demand, we have restarted the smaller Cleveland No.
6 blast furnace to make up for the lost Middletown production.
Once Middletown comes back, we will have another maintenance outage at Indiana Harbor No.
We currently have 10 blast furnace in our portfolio and are keeping between six and eight points in simultaneous operations.
At any given time, we will probably have some maintenance to perform.
We will manage all of these assets appropriately, without having any shortfalls with our customers, while also not what in the market with steel.
Value over volume is a simple philosophy that we will carry on into the future, and it is why you are not going to hear me talk about capacity utilization or even market share, except in automotive, but just because our leadership position on this one segment is still up.
Only as most liked of the recent steel price run-up positively impacted our fourth-quarter adjusted EBITDA performance of $286 million.
Due to how contract prices work and usually applies lagging mechanisms and the fact that we only controlled the AM USA assets for the last 23 days toward the end of the year, our steel profitability in the fourth quarter of 2020 has not benefited or improved from these strong prices just yet.
As a result, our EBITDA performance will dramatically improve in the first quarter of 2020.
In addition, we can confidently say that the second quarter will look even better than the first quarter, this very good first quarter that we are in now, as rising prices become further reflected, HBI shipments pick up pace and external pellet sales pickup with the reopening of the Great Lakes.
This current steel pricing environment has also highlighted the competitive advantages that our unique business model.
As we all know, EAF uses scrap as their primary feedstock.
The price for a ton of busheling scrap in the Midwest has almost doubled from where it was a little over a year ago.
Meanwhile, the cost of our primary iron feedstock, iron ore pellets we produce ourselves out of our own mine, is basically the same as it has been for the past five years.
Because of this, Cliffs has actually been your proverbial low-cost producer.
To make it clear, this is not even a tie I care to have because there is so much more to making steel than a low production cost.
You cannot reach safety first if you are obsessed with tons per employee.
You can't invest capital to protect the environment if you are governed by your production cost number.
And you will not pay your workforce well if cash cost is your main metric.
This is actually a capital-intensive industry, and we must work to generate return on invested capital and not for bragging rights based on a questionable and not always true low-cost position.
Hopefully, this current environment is a lesson on the blank statements made comparing cost positions, and we can put that subject to rest for good.
As I said, we don't believe this current scrap dynamic will be short lived.
China has publicly stated their target of doubling EAF capacity from 100 million metric tons to 200 million metric tons over the next five years.
The increase alone is bigger than the size of our entire domestic steel industry and will require a lot of scrap.
By 2025, China will be producing two and a half to three times more steel via the EAF route than the United States.
However, to move from where they are today to the level that they plan to be, China does not have the infrastructure in place to collect and deliver all that scrap, and the void will be filled by imported scrap into China.
That will come in large part from the United States, which has, by far, the largest and most mature scrap infrastructure in the world.
This is something we at Cleveland-Cliffs predicted several years ago and one of the reasons why we built our direct reduction plant.
With the already very large existing EAF capacity in the United States, the new EAF furnaces being built by the domestic mills here in the U.S., and the massive new EAF capacity coming online in China, all fighting for the same amount of scrap available.
We at Cleveland-Cliffs feel very comfortable with the powerful company we have built and with our self-sufficient [Inaudilble] business model.
The capital structure, underlying this best-in-class business model, was improved once again two weeks ago.
As you may recall, last April, at the beginning of the pandemic, when the automotive industry was out of operations, we issued a tranche of high-component secured bonds as insurance capital.
Now that business conditions have normalized, we sought to reduce the outstanding amount of these secured notes as much as possible.
And the only method to achieve that was by using the 35% equity cost provision from the indenture of the notice.
The sole focus of issuing the small number of 20 million shares was to use this claw-back provision and retire the maximum amount possible of these high-coupon notes without paying a make-whole panel.
This coincided with a block sale of about half of ArcelorMittal's CLF common shares that they received as part of the payment we made to them when we acquired AM USA.
These secondary shares were already outstanding and had no impact on share count.
We also successfully placed $1 billion of unsecured notes, the lowest coupons we have ever achieved as a high-yield issuer, respectively, 4.625% and 4.875% for eight- and 10-year issue.
These outstanding coupons and the same-day deal price execution, after spending just a few hours in the market, are a clear and unequivocal demonstration of the leveraged finance market support to our business model, strategy, and execution.
And at the end of the day, with this capital markets activity, we replaced secured debt with unsecured debt, lowered interest expense, cleared our maturity runway entirely all the way to 2025, and further improved our liquidity by using a portion for ABL repayment.
Finally, in January, we publicly announced our commitment to reduce greenhouse gas emissions by 25% by the year 2030, covering both the Scope one and Scope two emissions.
While we have transformed as a business, we will continue to operate Cleveland-Cliffs on the same environmentally responsible manner we have always done.
Climate change is one of the most important issues impacting our industry and our plants.
Our commitment includes using more natural gas to reduce our iron ore as we do in our direct reduction plant producing HBI, implementing clean energy and carbon capture technologies, and becoming more transparent on disclosing our products.
Before I get into the specific results that were foreshadowed with our pre-announcement a month ago, I will first discuss our new business segmentation.
You saw in today's release that we are now split into four segments, but the bulk of the operational and commercial activity will take place in our steelmaking segment.
The foundation for this is driven by how the management team views our business.
The strategic rationale behind our two major acquisitions was to form one large and competitive, fully integrated steel company, which is exactly what this segment represents.
This segment captures effectively all of the production activity that begins at our mine sites, including our pellet plants and other raw materials operations, and ends with our steel and finishing plants.
Products sold for this segment include slabs, hot rolled, cold rolled, coated, galvanized, stainless, electrical, tinplate, plates, rail, forgings, pellets, and HBI.
Our downstream units will remain as separate segments due to the different commercial nature of these businesses, though they remain an important piece of our integrated entity.
Because of this reporting change, we will not have any significant, noticeable intersegment eliminations going forward, other than the small impact from the finished steel sold to our downstream segments resulting in a much smoother and cleaner model.
As for our results, our fourth-quarter adjusted EBITDA of 286 million represented 127% increase over last quarter and 158% increase over last year's fourth quarter.
The sequential increase was driven by the following: increased steel shipments, higher prices, better costs due to increased production volumes, and reduced idle costs, the stub period contribution from the AM USA assets, and increased third-party pellet prices.
In the steelmaking segment, of our 1.9 million net tons of shipments, we shipped 1.25 million net tons from the AK side and picked up the remaining 600,000 from our 23 days of ownership of AM USA.
We expect to more than double this amount in the first quarter with total shipments of approximately 4 million net tons.
You will notice our average net selling price declined in the fourth quarter compared with the prior quarter, which was purely related to mix.
The AM USA assets we acquired do not sell stainless or electrical steels, which carry a much higher average selling price, bringing the overall average down.
Our shipments during the quarter were 44% coated, 22% hot rolled, 18% cold rolled, and 16% other steel, which includes stainless, electrical, slabs, plate, and rail.
Third-party pellet sales during the fourth quarter were about 2.0 million long tons which consists of approximately 1.6 million long tons sold to AM USA prior to the acquisition date.
Going forward, our external pellet sales volume should be 3 million to 4 million long tons per year, with the remainder of our output being used internally by our blast furnaces and direct reduction facility.
Our steel supply contracts are roughly 45% annual fixed price with resets throughout the year, and 55% HRC index-linked.
That latter piece further breaks down to about 40% on pricing lag, split between monthly and quarterly, with the remaining 15% on a spot basis that currently have lead times up to three months for hot-rolled and four months for cold-rolled, and coated products.
As Lourenco noted, given this structure and the short stub period for the new AM USA acquisition, the recent run-up in steel prices should accelerate in our results in the first quarter and continue its advancement into the second quarter.
When we completed the AM USA acquisition, we upsized our ABL facility from 2 billion to 3.5 billion, which is currently more than fully supported by our inventory and receivable balances.
This has provided us with a sizable liquidity balance of 2.6 billion as of this week, of which approximately 850 million is earmarked for bond redemptions set to take place in March related to the capital markets transactions we completed earlier in February.
Most of the other significant changes to our balance sheet, like PP&E and goodwill, are attributable to standard acquisition accounting.
As for cash flow, our fourth quarter was impacted primarily by changes in working capital, most notably receivables and inventory.
Because of the factoring arrangement AM USA had in place prior to the acquisition that was terminated at closing, we began rebuilding the receivable balance in December, which was factored into our valuation for the acquisition.
We will continue to build working capital in the first quarter, after which it will then normalize and become a source of cash for the remainder of the year.
Our fourth-quarter capital expenditures of 147 million took into account spending for the AM USA assets during the last 23 days of the year and included $61 million related to the Toledo plant, where we have about 60 million in run-out spend going into 2021.
This is included in our 600 million to 650 million capital budget for 2021, which includes about 500 million in sustaining capex, as well as other small projects such as the new precision partners plant in Tennessee, walking beam furnaces at Burns Harbor, and the Powerhouse at Cleveland Works.
In closing, with the completion of our two transformative acquisitions and the recent capital structure activity we completed two weeks ago, the company is on solid financial ground with no cash taxes to pay and manageable capex, interest, post-employment obligations, we are primed to generate significant free cash throughout 2021.
We will use this excess free cash flow to continue to reduce our debt balance, and we will have ample opportunity to do so in the current market environment.
What a year 2020 was, and what a phenomenal company we have formed during 2020.
Rather than panic during the most challenging days of the pandemic, we went on the offensive and took advantage of the amazing opportunities out there to improve not only ourselves but also to change for good the steel business environment in the United States.
As the new Biden administration starts to work toward infrastructure, manufacturing, environmental responsibility, and good pay middle-class union jobs, we believe we have just built the perfect company to thrive in these challenging times that we are in.
We are ready to make our market on the industry with our 25,000 employees all rowing in the same direction, and we can't wait to show you what we can accomplish.
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cleveland-cliffs - with contribution of steel sales from cleveland-cliffs steel llc for full quarter, expect q1 steel product shipments of about 4 million net tons.
full-year 2021 capital expenditures are expected to stay in range of $600 million to $650 million.
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Let me start by highlighting some of our full-year financial accomplishments in 2021.
Our revenues of $20.4 billion, net income of $3 billion, adjusted EBITDA of $5.3 billion, and free cash flow of $2.1 billion were all-time annual records in our company's history.
The M&A consolidation that we executed in 2020 was a huge driver of the industry market conditions that led to the outstanding annual results that we achieved in 2021.
With this record annual profitability, we put the cash we generated to good use.
We reinvested in our business, acquired the leading prime scrap processor in North America, delevered our balance sheet, and reduced our diluted share count by 10% last year.
Just to give you an idea of how 2022 is going so far, on a year-over-year basis, we have already generated more adjusted EBITDA in January of 2022 alone than we did in the entire first quarter of 2021.
Now, focusing back on our Q4 2021 results.
Last quarter, we generated adjusted EBITDA of $1.5 billion on 3.4 million tons of steel shipments, the second-best quarterly performance in our company's history, only behind the previous quarter's $1.9 billion adjusted EBITDA on 4.2 million tons shipped.
The main driver of this quarter-over-quarter decline in EBITDA from Q3 to Q4 was this shipment reduction.
Additionally, service centers and distributors pulled even less tons than usual during this already typically weak period in late November and December.
Remaining steadfast in our disciplined supply strategy and based on this rebound we expected and are already seeing from our automotive clients this year, we elected to move up several operational maintenance outages originally planned for 2022 into the fourth quarter of 2021.
These actions reduced our sequential quarter-over-quarter steel production by 675,000 crude tons in Q4, ultimately also impacting our unit costs.
Partially offsetting the volume and cost impacts were higher selling prices in Q4, which rose by approximately $90 per ton from $1,334 to our highest level of the year of $1,423 per net ton.
This is also only an early indication of the success we have achieved in renewing our fixed price sales contracts as only a portion of our contract renewals were already in place during Q4 of 2021.
Remember, the majority of our renewals were not in place until January 1, 2022.
As this year progresses, the selling prices we report every quarter going forward will continue to demonstrate the successful renewal of these fixed-price contracts, and that will be even more evident if the index HRC price continues to drop.
For context, if we applied the contracts we have in place now in 2022 to the fourth quarter of 2021, holding all else constant, our Q4 2021 adjusted EBITDA would have been nearly $500 million higher.
This level of fixed contracts is the key differentiator in favor of Cleveland-Cliffs relative to all other steelmakers in the United States and gives us significant visibility into our cash flows for 2022.
Despite the lower shipments and additional inventory build, we generated $900 million of free cash flow in Q4 of 2021.
Of this $900 million, we used $761 million to acquire FPT and use the remaining $150 million or so to pay down debt.
So, in other words, with only one quarter's worth of free cash flow, we were able to pay for a meaningful acquisition and still had enough cash flow left over in the quarter to pay down some debt.
Now, speaking of our debt, we have already accomplished a lot more than we originally expected in terms of improving our leverage.
We keep a close eye on our overall debt levels on a dollar basis, but we also look at our overall leverage on a total debt-to-last 12 months adjusted EBITDA basis.
With total debt and LTM adjusted EBITDA at essentially the same level, at the end of 2021, we are at a total leverage of only one time.
By next quarter, our LTM-adjusted EBITDA will likely be even higher, which will continue to further reduce our overall leverage metrics.
As a reminder, our leverage was over four times in 2019, pre-COVID and before our transformation.
While overall leverage is in great shape, we will continue to simplify our capital structure by paying down debt, replacing existing bonds with cheaper ones, and extending debt maturities.
The significant free cash flow we anticipate in 2022 should allow us to pursue the dual goals of repurchasing shares and reducing debt.
We have already redeemed our convertible notes in 2022 and several other tranches of our bonds become callable this year at pre-negotiated prices, including the two tranches of secured notes we issued in 2020.
We fully intend to redeem or refinance these notes at some point in 2022.
As expected, last year, we built a substantial amount of working capital, which should be worked down throughout this year.
Given this increased collateral base, we were able to take advantage of these asset levels and upsized our ABL facility last quarter, increasing our available liquidity by $1 billion to our current level of $2.6 billion.
On another very important note on the balance sheet, our net pension and OPEB liabilities saw a $1 billion reduction during Q4, primarily due to actuarial gains and strong asset performance, leading to a $1.3 billion or nearly 30% net reduction during 2021.
Also importantly, in the rising rate environment that we are in today, we have meaningful potential for further pension and OPEB liability reductions.
Just for reference going forward, for every 50-basis-point increase in our discount rate, our expected liabilities would decline by about $500 million, all things equal.
Looking ahead, even under today's pessimistic HRC futures curve, we would expect higher overall average selling prices in 2022 than we saw in 2021 when HRC averaged $1,600 per ton.
On the cost side, we expect to see increases related to energy and materials, with the largest annual change in coal and coke.
Countering this, we have been offsetting our coke usage by increasing the usage of HBI in our blast furnaces and increasing the percentage of scrap in the charge of our BOFs.
Our capex budget for this year is $800 million to $900 million, an increase from the previous year, primarily due to an additional reliability and environmental projects, inflation and the reline of one of our Cleveland blast furnaces, which will be out for over 100 days during Q1 and Q2.
Full-year DD&A should be about $900 million.
Exclusive and one-time items, our 2022 SG&A expense should be around $520 million, which includes higher wages and also $40 million of FPT overhead.
Now that we have effectively exhausted our tax NOLs, our cash tax rate should be in the 15% to 20% range, with our book tax rate at 21%.
Our first full calendar year as the new Cleveland-Cliffs was an absolute success, and we could not have accomplished all the great results we were able to accomplish without the hard work and commitment of our 26,000 employees, approximately 20,000 represented by the USW, the UAW, the Machinists, and other unions.
We believe in manufacturing in the United States and in good-paying middle-class jobs.
We really appreciate the work of each one of our employees and the unions representing them.
We could not have done all that without you.
As great as 2021 was for Cleveland-Cliffs, we would have done even better if the automotive industry had resolved their supply chain problems.
The shortage of microchips cut their opportunity to build 18 million cars or more in 2021.
And the automotive sector ended the year with a much smaller 13 million units.
When we at Cleveland-Cliffs realized in the third quarter of 2021 that our automotive clients were still not performing up to the level that they were guiding us to build inventories for them, we then made the decision to move up to Q4 some important maintenance jobs originally scheduled for the first four months of 2022.
That decision, albeit correct, has clearly impacted our Q4 results.
Now with the first month of 2022 behind us, we are starting to see improved deliveries to our automotive clients.
While it is just a one-month data point, deliveries to automotive clients in January were stronger than each of the previous three months: October, November, and December.
And our adjusted EBITDA in January was a solid $588 million.
Furthermore, as the microchip shortage improves during 2022, the automotive companies will need a lot more steel this year than in 2021.
This steel comes primarily from Cleveland-Cliffs.
We are, by a huge margin, the largest supplier of steel to the automotive industry in the United States.
Let's make this abundantly clear to our investors.
There is no other steel company, integrated or mini mill, in the U.S. or more broadly in North America capable of supplying all the specs and all the tonnage we supply the American automotive industry.
Cleveland-Cliffs already has all the equipment and technological capabilities that other companies are only now spending several billions of dollars to try to replicate by building new melt shops and new galvanizing lines.
We typically sell 5 million tons of steel directly to automotive manufacturers and also sell another 2 million to 3 million tons through intermediaries.
Put another way, almost half of our steel sales ends up in automotive functions.
Another interesting fact, even though we have not deliberately tried to grow our automotive market share in 2021, we have actually increased our market share through tons resourced by our clients.
While the clients do not tell us why they are taking the order away from another steel company and reassigning this specific item to Cleveland-Cliffs, we can only assume that these other steel companies are not meeting the automotive industry's high standards.
That's probably why these competitors have to invest several billions of dollars to play catch-up.
Cleveland-Cliffs does not have to spend this type of money and will not.
With our capex needs in 2022 relatively low and strong confidence in our cash flows, we are very comfortable putting in place the $1 billion share buyback program just announced.
Another differentiating big feature of our way of doing business is the predictable pricing model that we have in place with automotive and tin plate and some select clients in other sectors as well.
This feature eliminates the worst cancer in our industry, which is self-inflicted volatility.
Going forward, we will work with more clients to move sales under this model.
Real clients don't need indexes.
They need reliable suppliers and fair prices.
We currently sell about 45% of our volumes under annual fixed-price contracts, by far, the highest in our industry and we want this number to continue to grow.
The harm caused by the volatility of steel pricing is most damaging for smaller service centers, who leave out of their inventory values.
Ironically, these same folks are the ones who create volatility in the first place, panic buying, double and triple ordering when supply is tight, and then halting purchases altogether when inventories are temporarily adequate, perpetuating a never-ending cyclicality.
We are convinced that it is in everyone's best interest to limit volatility in our industry.
And that's not only desirable but also feasible.
That's why we are moving away from sales to smaller players, further concentrating on the larger clients, which already make up the vast majority of our sales.
At this point, all important clients of Cleveland-Cliffs are being offered index-free deals to continue to do business with us.
Marrying stable costs with stable prices up and down the supply chain can create a much healthier business environment for steel in the United States.
Another ongoing important matter for the future of Cleveland-Cliffs is our commitment to ESG.
That was evident with our purchase of FPT, the national leader in prime scrap, which was completed in the fourth quarter.
The integration of FPT has gone remarkably well, and we are grateful for the buy-ins of the 600 employees of FPT, they are now employees of Cleveland-Cliffs.
Since closing the deal on November 18, we have made substantial moves securing a number of additional sources of prime scrap uptake.
Most notably, the largest automotive stamping plant in the country.
This particular stamping plant alone generates more than 150,000 tons of prime scrap per year.
Our agreement replaced an incumbent scrap company, who had been servicing this stamping plant for decades, even before this scrap company was acquired by a mini mill several years ago.
Our deal was made possible with a compelling proposition.
This automotive manufacturer buys the steel primarily from Cleveland-Cliffs, and now we can feed their scrap directly back to our steelmaking shops.
This is not just recycling steel, it's a real closed loop.
A closed-loop is a key piece of our automotive clients' environmental strategy, as well as a key piece of our own environmental strategy at Cleveland-Cliffs.
On the carbon emission side, we continue to lower our usage of coal and coke by increasing the utilization of HBI as a significant part of the burden in our blast furnaces.
While our flagship direct reduction plant in Toledo was originally built to supply third parties EAFs with HBI, this HBI is now being exclusively used in-house within Cleveland-Cliffs; the vast majority in our blast furnaces, playing a central role in lowering both our coke rate and our CO2 emissions.
Furthermore, we are currently working with Linde, our largest supplier of industrial gases, to implement the utilization of hydrogen in Toledo.
As you may know, our state-of-the-art direct reduction plant was originally designed and built with the possibility of using up to 70% of hydrogen in the mix as reductant gas.
We expect to report on the usage of hydrogen and the production of the first hydrogen-reduced HBI in steel in 2022.
The same goes for our iron ore pellets, another key competitive advantage we have and a driver of lower emissions relatively to foreign competition that uses primarily sinter feed ore in their blast furnaces.
Going forward, we will be limiting the tonnage of iron ore pellets we sell to third parties.
Iron ore is a finite resource and the time and cost it takes to get permits and extend life of mine is incredibly cumbersome.
In addition, iron ore pellets are Scope 1 emission for Cleveland-Cliffs, but they are Scope 3 emissions for the clients we sell them to.
Unfortunately, the Scope 3 emissions are not accounted for, not counted in anyone's reduction targets and surprisingly, at least for now, no one really seems to care about Scope 3 emissions, therefore, producing fewer tons of pellets automatically reduce our Scope 1 emissions.
And that's good enough for us, at least until Scope 3 becomes a topic of concern.
Also, with the use of additional scrap in our BOFs, our iron ore needs are not as high as before, and we no longer need to run our mines full out.
When determined where to adjust production, our first look is at our cost structure because we are now able to produce DR-grade pellets at Minorca and mainly due to the ridiculous royalty structure we have in place with the Mesabi Trust.
We will be idling all production at our Northshore mine, starting in the spring, carrying through at least to the fall period and maybe beyond.
At Northshore, no production, no shipments, no royal payments.
With more scrap in the BOFs, we need fewer tons of hot metal to produce the same tonnage of liquid steel.
As a consequence, the Northshore idle could go longer than currently planned.
As another consequence of our strategy of hot metal stretching, we have dramatically lowered our needs for coke and coal.
We already announced last quarter that we idled our coke battery at Middletown.
Now that our coke needs have been reduced even more, in the second quarter of 2022, we will also permanently close our Mountain State Carbon coke plant.
This action will not only further improve our carbon footprint but will also save us approximately $400 million in capex originally planned for this facility over the next few years.
Even though jobs are going to be eliminated at Mountain State Carbon, we have enough job openings at other nearby Cleveland-Cliffs facilities.
And we can ensure all good employees will have other employment opportunities within our company.
On that note, the last piece of our environmental strategy relates to how we operate our eight blast furnaces.
Our presence in highly specified automotive grade materials, particularly exposed parts, necessitates the use of blast furnaces.
EAFs continue to be unable to demonstrate that they can compete and produce the entire spectrum of specs demanded by the car manufacturers.
That's the main reason why all the major steel suppliers located in countries with a strong presence of automotive manufacturing like in Japan, in South Korea, in Europe, and here in the United States, are not mini-mills operating areas.
They are all integrated steel mills with blast furnaces and BOFs.
Cleveland-Cliffs is the one here in the United States.
And we do not use the sinter, we use only pellets and HBI in our blast furnaces, enabling us to establish the new world benchmark in low coke rates and low emissions.
This is particularly relevant when our automotive clients, with a worldwide presence, compare Cleveland-Cliffs against their other well-known automotive steel suppliers from countries like Japan, South Korea, Germany, Austria, Belgium, or France, among others.
Our full control over the entire supply chain from pellets to HBI to prime scrap creates a huge differentiation in favor of Cleveland-Cliffs, one that is impossible to replicate in Asia or in Europe.
That said, we also produce a lot of steel that goes to less quality intensive end users.
A blast furnace reline is a capex-heavy undertaking, albeit totally expected in our multiyear projections.
Under this evaluation process, we also take into consideration other upgrades to the upstream hot end, as well as the capital related to extending the life of mine of our iron ore mines.
With all that, in some cases, the capital requirements of a new EAF compared to the avoidance of reinvesting in a blast furnace reline and its associated supply chain could come out close to a wash, particularly because we at Cleveland-Cliffs already have the rolling and coating capabilities in place.
If and when that happens, the wash or better, we might consider an EAF as a replacement to a blast furnace reline in the future.
One final piece on the environmental to note.
Of all CO2 emissions generated in the United States, the emissions related to the production of steel represent just 1% of the total.
One more time, just 1%.
This number is 15% in China and 7% worldwide.
But here in the United States, it is just 1%.
The steel industry in the United States is the most environmentally friendly in the entire world.
Meanwhile, transportation, particularly affected by automotive tailpipe emissions, is responsible for 29%, while energy is responsible for another 25%.
This is where the importance of steel made in U.S.A. is most significant as our very small emissions footprint, again, just 1%.
We will play a critical role in improving the emissions of these two sectors, which, combined, are responsible for more than 50% of all CO2 emissions in the United States.
For one, Cleveland-Cliffs has been prepared for the transition from ICE to electric vehicles long before EV's rapid adoption.
And we have the right steels necessary to meet the automotive industry target of 50% EV adoption by 2030.
On the energy side, we need more renewables, like solar and wind, and both are steel-intensive.
Cliffs is the only producer in the United States of the electrical steels needed for the modernization of the electrical grid, which received $65 billion in funding under the recently passed infrastructure bill.
Our non-oriented electrical steels, we call it NOES, is used for motors in both hybrids and BEVs.
The infrastructure bill also includes another $7.5 billion earmarked for charging stations for electric vehicles.
Each charger uses approximately 50 pounds of GOES, grain-oriented electrical steel, and we are talking about half a million of charging stations, plus the equivalent amount of transformers to tie down these charging stations into the grid.
With all that and no other producer of GOES or NOES in North America other than Cleveland-Cliffs, in 2022, we have a more than full order book for electrical steels.
And that's just the beginning of the EV revolution, which will certainly progress between now and 2030.
With all we at Cleveland-Cliffs are doing related to carbon emissions, I can't believe so many companies are being given a free pass by the investment community, despite not doing much more than just saying they will be carbon-neutral by 2050.
What I have just laid out here are real, concrete, undeniable measures to reduce emissions, and we are implementing them all companywide at Cleveland-Cliffs.
We will continue to be able to track our progress in 2022, 2023, 2030, and beyond.
And we will watch how much others will actually do here in the United States and abroad.
The future, and specifically, 2022, is clearly bright for Cleveland-Cliffs.
Underlying demand remains strong, infrastructure-related spending has started, particularly regarding electrical steels.
And the chip shortage affecting the automotive has begun to ease, leading to meaningful pent-up demand for cars and trucks.
That should benefit Cleveland-Cliffs a lot more than any other steel company in the United States.
In the meantime, we will take full advantage of the market's lack of appreciation or lack of understanding of our business by buying back our stock, all to the benefit of our loyal shareholders.
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compname reports full-year and fourth-quarter 2021 results and announces $1 billion share repurchase program.
q4 revenue $5.3 billion versus $2.3 billion.
as of february 8, 2022, company had total liquidity of approximately $2.6 billion.
expect to see higher average selling prices for our steel in 2022 than in 2021.
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Slides for today's call are posted on our website and we invite you to follow along.
Participants are cautioned not to place undue reliance on these statements, which reflect management's opinions only as of today, November 4, 2020.
Information on potential factors and risks that could affect our actual results of operations is included in our SEC filings.
The company undertakes no obligation to revise or publicly release the results of any revision to the statements made in today's call, other than through filings made concerning this reporting period.
In addition, today's discussion will include references to non-GAAP measures.
Clean Harbors believes that such information provides an additional measurement and consistent historical comparison of its performance.
Starting on Slide 3.
We delivered exceptional results in Q3.
And I can't say enough about the efforts of our team in driving these outstanding performance.
Since the outset of the pandemic in March, everyone from really the top levels of the organization to our frontline workers have excelled in response to this challenge, and it's truly been a team effort.
At its core, Clean Harbors is a crisis response company and we can still thrive in difficult environments like the one we have all faced over the past eight months.
And the resiliency of our organization and the versatility of our business model clearly were evident here in Q3.
Revenue, while down year-over-year due to the unprecedented market conditions, was up nearly $70 million on a sequential basis.
This growth was driven by an accelerated recovery in several core lines of business in our Environmental Services segment.
At the same time, we also saw a strong sequential pick up within Safety-Kleen.
Adjusted EBITDA of $161.2 million included $13.3 million in government programs, primarily from the revised CEWS legislation in Canada.
The high level of EBITDA supported by controlled capital spending resulted in adjusted free cash flow of $123.5 million, a quarterly record for the company.
Mike will review the P&L in more details in his remarks.
Turning to our segment results on Slide 4.
Environmental Service revenues declined 10% from a year ago but were up 6% from Q2.
As many of our service businesses bounced back from the early days of the pandemic, adjusted EBITDA grew 16%.
This increase was attributable in part to our cost reduction efforts, productivity improvements and a healthy mix of higher margin work.
The two government programs accounted for $10 million of adjusted EBITDA in this segment.
Revenue from our COVID-19 decon work totaled $29 million and our team has now completed a total of more than 9,000 COVID-19 responses.
Though incineration utilization dipped to 80% due to the timing of turnarounds and a production lag from some of our customers, we continue to execute on our strategy to capture high-value waste streams across our network.
This resulted in an average price per pound increase of 5% from the year earlier period.
Landfill volumes declined 6% as strong base business largely offset the lack of remediation and waste project opportunities.
Moving to Slide 5.
Safety-Kleen revenue was down 18% from a year ago, but up 17% sequentially due to the recovery in both the branch and the SK Oil businesses.
The lifting of local restrictions across much of North America led to a sharp increase in vehicle miles driven, generating higher lubricant demand.
The recovery in demand for base oil and lube products enabled us to restart three of our rerefineries during Q3.
Given the declining market value of waste oil, we maintained high charge-for-oil rates used for motor oil and increased our collection volumes to 50 million gallons.
That is 16% ahead of Q2.
Safety-Kleen's adjusted EBITDA declined 15%, mostly due to the lower revenue.
This decline was partly offset by our cost reduction initiatives, as well as the government assistance programs that provided $2.5 million to this segment in Q3.
Parts washer services we're off 10% in the quarter, which was promising given that we originally expected the SK branch business to be at 85% of normal levels in Q3.
Percentages of blended products and direct volumes came in as expected, but at lower volumes overall.
Turning to capital allocation on Slide 6.
In light of the pandemic, our strategy has been more about capital preservation to ensure that we exit this global crisis well positioned for growth, and I am confident that we will.
Capex spend was extremely low in the quarter and we will continue to proceed with caution on every internal dollar spend.
That being said, we continue to invest in certain projects, particularly at our plants that we believe will generate a strong return.
In terms of M&A activity, opportunities are available, and we have been exercising patience, though, as we believe that we can be more opportunistic going forward in light of the pandemic.
In terms of share repurchases and debt repayment, we are active on both fronts in Q3.
Looking ahead, we enter the final quarter of 2020 in great shape.
On the sales side, we are working closely with customers to help drive a measurable recovery in many of our core businesses.
Our national footprint, reputation for safety, and emergency response capabilities have been competitive differentiators for us.
On the bottom line, our prudent cost actions and careful capital spending have helped us generate record margins and cash flow -- free cash flow in the past two quarters.
Our decontamination business continues to serve as a natural hedge against further slowdowns in other parts of our company.
Within Environmental Services, we expect strong incineration utilization in Q4 based on the lower planned turnaround days and the availability of waste in the marketplace.
We anticipate our offerings within Industrial Services and Tech Services to close out the year on an upward trajectory.
Field Services remains on track for a phenomenal year due to the COVID-related revenues, which we expect to exceed $100 million.
Within Safety-Kleen, we remain below normal demand levels, but we've seen a vast improvement from the lows of the April-May timeframe.
We're continuing to monitor and manage the impacts of localized COVID outbreaks.
Obviously, new shelter-in-place mandates could derail our recovery in the Safety-Kleen branch business, but to-date, we have seen nice steady recovery since both the U.S. and Canada reopened.
For Safety-Kleen Oil, our primary rerefineries are all back online, and base oil pricing is stable due to the supply conditions brought about by recent hurricanes along the Gulf Coast.
We continue to actively manage our charge-for-oil rates as we seek to further grow our collection volumes to supply our network.
So in conclusion, we are encouraged about our overall prospects as we enter the final quarter of 2020.
Our Q3 results confirm the resiliency of this company.
Despite the economic uncertainties that all companies are facing in today's environment, we are confident that we have put our company in the best position possible to succeed as we close out 2020.
Our company clearly delivered outstanding results this quarter.
I want to echo Alan's remarks about the organization.
We have an outstanding team that is able to meet the needs of our customers during a crisis like the pandemic in ways most companies cannot.
It's not just the decontamination work where we are heading into locations that others have evacuated for safety reasons.
It is the fundamental DNA of Clean Harbors and how this company measures up to challenges.
We excel at generating new revenue streams, meeting customer needs during times of disruption and improving operational efficiencies, all while doing it safely and under rapidly evolving health protocols.
I said it to open my remarks last quarter and they're worth repeating.
I couldn't be more proud of the way our organization had met the challenges of this pandemic head on.
Turning to Slide 8 and our income statement.
Our third quarter results exceeded the expectations we set when we resumed guidance in August.
Revenue declined 13% year-over-year, but on a sequential basis, was up nearly $70 million.
Preparing for the possibility of a protracted downturn, we have continually -- we have continued to aggressively manage our cost structure.
These comprehensive efforts, combined with assistance we received from government programs, mostly Canada this quarter, resulted in a 310 basis point improvement in gross margins.
Adjusted EBITDA increased to $161.2 million from a year ago.
Excluding the government assistance, adjusted EBITDA would have been $147.9 million, down only 6% year-over-year, despite revenues being 13% lower.
Adjusted EBITDA margins of 20.7% was 310 basis points -- was up 310 basis points from last year's third quarter, which speaks to the effectiveness of our actions.
We have now improved our adjusted EBITDA margins on a year-over-year basis for 11 consecutive quarters.
Given our lower revenue, our SG&A total was down in the quarter, but our performance also demonstrated the benefits of our cost reduction and productivity efforts.
We lowered SG&A by nearly $16 million or 13% in Q3.
Of that total, $2.8 million was related to the impact of CARES and CEWS.
I would like to point out that these programs have been critical to support headcount levels higher than they would have otherwise been both here and in Canada.
In the quarter, we saw the full impact of the series of productivity programs and cost actions we initiated in Q2.
Our ability to rapidly flex down our structure and maintain expenses at a lower level, even as revenues were coming back, was a key factor in our strong third quarter results.
For full year 2020, we are targeting SG&A of approximately 14.5% of revenue, continuing a positive trend that began several years ago.
Depreciation and amortization in Q3 was up slightly at $74.5 million.
For the full year, we continue to expect depreciation and amortization in the range of $285 million to $295 million, which is slightly below last year.
Income from operations increased by 4%, reflecting the higher gross profit and our overall effectiveness at managing the business.
Earnings per share was $0.99 in Q3 versus $0.65 a year ago or $0.90 versus $0.72 on an adjusted basis.
Turning to Slide 9.
We concluded Q3 with our balance sheet in great shape.
Cash and short-term marketable securities at September 30 exceeded $530 million.
Our liquidity increased even though we paid back the remaining $75 million of funds we had drawn on the revolver under the abundance of caution when the pandemic began.
Our payables and receivable balance grew in the quarter, along with the business, but both categories remain well below last year levels and our collections team is doing an outstanding job keeping cash coming in the door.
Our debt obligations decreased to below $1.56 billion with the paydown of the revolver.
Leverage on a net debt basis now sits at 1.9 times for the trailing 12 months ended 9/30, which is our lowest level in nearly a decade.
Our weighted average cost of debt remains at an attractive 4.2% with a healthy blend of fixed and variable debt.
Last week, we renewed our revolving credit facility with our lending group, led by Bank of America, and we're grateful for their continued strong support.
We put a new five-year $400 million lending facility in place.
We typically uses asset-backed loan agreement only for letters of credit.
Turning to cash flows on Slide 10.
Cash from operations in Q3 was nearly flat with prior year at $143.9 million.
Capex, net of disposals, was down more than 60% to $20.4 million, reflecting our COVID response plan to be extremely cost prudent with our capital.
The result was record adjusted free cash flow in Q3 of $123.5 million, which is 35% ahead of 2019.
For the year, we continue to target capex, net of disposals and excluding the purchase of our headquarters, in the range of $155 million to $175 million.
During the quarter, we stepped up our share repurchases as we bought back 400,000 shares at an average price of just over $55 for a total buyback of $22.2 million in Q3.
Year-to-date, we have we repurchased slightly above 700,000 shares.
Of our authorized $600 million share repurchase program, we have $245 million remaining.
Moving to guidance on Slide 11.
Given our performance, and based on current market conditions, we are raising our 2020 guidance.
We now expect 2020 adjusted EBITDA in the range of $530 million to $550 million.
While this guidance assumes continued localized outbreaks of the virus, it does not assume a national shelter-in-place order due to COVID-19.
This also -- this guidance also assume $3 million to $5 million of government subsidy money in Q4.
Here's how our full-year 2020 guidance translates from a segment perspective.
In Environmental Services, we expect adjusted EBITDA to grow in the low-teens percentage above 2019's level of $446 million.
Growth and profitability within incineration, contributions from the expected $100 million-plus of decontamination work, government assistance programs, and a rebound in the majority of our services business and comprehensive cost measures, are driving this positive result.
For Safety-Kleen, we anticipate adjusted EBITDA to decline in the high-teens percentage from 2019's $282 million.
We expect the branch business to remain below pre-COVID levels in Q4, but we -- but continuing to improve from Q2 levels as it did in Q3.
At the same time, we expect SK Oil to continue its recovery from Q2 where we temporarily closed our rerefineries.
We have continued to be successful at aggressively managing the front end of our rerefining spread.
In our Corporate segment, we expect negative adjusted EBITDA to be up a few percentage points from 2019's $188 million due to increases in 401(k) contributions, environmental liabilities, severance and bad debt, mostly offset by lower incentive compensation and cost savings.
Based on our current EBITDA guidance and working capital assumptions, we now expect 2020 adjusted free cash flow in the range of $250 million to $270 million.
We believe this puts us in an enviable position to execute the cost allocation strategy that Alan outlined.
To summarize, the company delivered an exceptional quarter both operationally and financially.
We enter the last quarter of the year with fairly strong momentum across our facilities network, including our rerefineries and within the majority of our service businesses.
For the most part, the macroeconomic end markets we serve continue to improve.
Chemical and industrial production, which paused a bit in Q2, began to resume in Q3.
As more parts of the economy have reopened in the U.S. and Canada, vehicle miles driven has increased.
We see a steady march forward to close out the year, albeit with normal seasonality in some of our businesses.
We also are beginning to see some project and turnaround work pushed out until 2021, along with new opportunities such as PFAS actually benefit us down the road.
But overall, we believe the short term and longer-term trends within both our operating segments favor us.
We look forward to closing out 2020 on a strong note and we are well-positioned as we head into 2021.
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q3 adjusted earnings per share $0.90.
q3 earnings per share $0.99.
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slides for today's call are posted on our website, and we invite you to follow along.
Participants are cautioned not to place undue reliance on these statements, which reflect management's opinions only as of today, February 24, 2021.
Information on potential factors and risks that could affect our actual results of operations is included in our SEC filings.
The company undertakes no obligation to revise or publicly release the results of any revision to the statements made in today's call other than through filings made concerning this reporting period.
In addition, today's discussion will include references to non-GAAP measures.
Clean Harbors beliefs that such information provides an additional measurement and consistent historical comparison of its performance.
Starting on slide three.
We concluded 2020 with a strong fourth quarter.
Our Environmental Services segment outperformed our expectations, driven by a combination of factors, including the level of high-value waste in our disposal network, greater-than-expected COVID decontamination work and ongoing cost controls.
Total fourth quarter revenues were in line with expectations as our Safety-Kleen business remained constrained by the effects of the pandemic.
Adjusted EBITDA in Q4 increased to $136.1 million, which included $5.6 million in benefits from government programs, primarily from Canada.
For the full year, adjusted EBITDA grew by 3% to $555.3 million, with annual margins growing to 17.7%.
We generated record adjusted free cash flow of $265 million, a noteworthy accomplishment considering the economic disruption caused by the pandemic.
Without question, the success we achieved in 2020 is a direct result of the dedication, flexibility and perseverance of our exceptional team.
2020 was a challenging year on many levels.
Turning to our segment results, beginning with Environmental Services on slide four.
Revenue, while down year-over-year due to a market -- due to market conditions, was up on a sequential basis.
Typically, Q4 is a seasonally weaker quarter for us, but the $18 million increase from Q3 is evidence that many of our markets are on the road to recovery.
We also saw strong disposal and recycling volumes to close out the year.
Adjusted EBITDA grew by 13% from a year ago, with margins up nearly 400 basis points.
This was driven by a combination of business mix, cost savings and $3.9 million in benefits from government assistance programs in Q4.
Revenue from our COVID-19 decon work totaled $31 million in Q4.
For the full year, our team completed nearly 14,000 responses and was an essential resourcing and protecting our customers' people and facilities.
In Q4, we benefited from a record level of drums collected as well as some high-value complex waste streams we received into our network.
This resulted in an average price per pound increase of 16% from the year earlier period when we saw more bulk streams.
Incineration utilization in the quarter was 84% due to a higher-than-expected number of maintenance days.
Landfill volumes were down 37% in the quarter as the lack of remediation and waste projects opportunities intensified with the resurgence of the pandemic.
However, our strong base landfill business largely offset that decline with a 42% increase in our average price per ton.
Moving to slide five.
Safety-Kleen revenue was down 15% from a year ago, but was flat sequentially as the ongoing recovery offset normal year-end seasonality.
Vehicles miles driven had been on a nice upward trajectory throughout the summer, but plateaued a bit in Q4, with the COVID-19 surge resulting in some new local restrictions in areas such as California, and all across Canada.
Most of our core services in the SK branch business were down year-over-year as a result, but flat from Q3.
Safety-Kleen's adjusted EBITDA declined 21%, mostly due to the lower revenue and business mix.
This decline was partly offset by our cost reductions initiatives as well as the government assistance programs that provided $1.4 million of benefits in Q4.
Waste oil collections were 49 -- no, excuse me, were 49 million gallons in Q4 with a healthy average charge for oil, given the lack of available outlets for generators.
On the SK oil side, we saw typical seasonal softening of the demand for base oil and lube products.
However, due to lower production levels in the traditional refinery space, available base oil and lubricant supply shrank in the quarter, resulting in a rising price environment that should benefit us here in 2021.
Percentages of blended products and direct volumes came as expected and consistent with prior year.
Turning to slide six.
Looking back at 2020 from a capital allocation standpoint, our strategy due to the pandemic was focused on capital preservation, which served us well.
capex in Q4 was slightly higher than the prior year, but our full year spend was down from 2019.
Moving forward, we expect to focus on internal growth capital on our plants and other assets that we believe generate the best returns.
From an M&A standpoint, our opportunity pipeline is healthy, as businesses emerge from the pandemic, and we gain a clear light -- line of sight on our end markets.
We prudently increased our level of share repurchases in Q4 and had an active repurchase program for the year, and Mike will provide the detail on our buyback shortly.
Looking ahead, we're beginning 2021 in excellent shape, both operationally and financially.
The markets we serve are on an upward trajectory.
For our lines of business that have been held back by the pandemic, such as waste projects and remediation, we expect a measurable recovery this year.
In 2021, we expect to pursue growth opportunities through our core suite of offerings and by capitalizing on market conditions.
And Mike is going to talk about our new sustainability report in a moment.
But let me say that we expect to take full advantage of the growing market acceptance of our sustainable offerings in 2021 and beyond.
We provide a broad array of green solutions that go well beyond our role as the largest collector and recycler of waste oil.
Within Environmental Services, we entered the year with higher deferred revenue and given the availability of waste in the marketplace, expect strong incineration performance in 2021.
We anticipate our offerings within Industrial Services and Tech services to grow from last year.
We expect Field Services to generate $25 million to $35 million of COVID-related revenues in 2021.
Within Safety-Kleen, we remain below normal demand levels as we kick off 2021.
However, later this year, we anticipate a steady recovery in the SK branch business.
For Safety-Kleen Oil, our rerefineries are producing well.
And as I mentioned, pricing for both base oil and blended products is favorable to start the year.
We will continue to actively manage our charge for oil rates, while focusing on growing collection volumes to supply our rerefinery network and take advantage of market conditions for recycled fuel oil.
As I look at 2021, the underlying dynamics in both our operating segments remain positive, and we expect a strong sales growth year with healthy free cash flow as a result.
I anticipate another great year for the company in 2021.
Before I take you through the financials, let me comment briefly on our first ever sustainability report, which is available on the IR section of our website.
We're proud of this document, which we created based on the Sustainability Accounting Standards Board framework.
The document highlights the integral role that sustainability plays in our business decisions as well as our environmental, social and government goals and benchmarks for 2030.
The At a Glance page of the report shown on slide eight is an overview of some of the -- of our ESG benchmarks.
I want to reiterate the point that Alan made about ESG and sustainability as foundational to our business.
For many customers, we are their sustainability solution.
When companies generate potentially harmful byproducts, they call Clean Harbors to safely remove and dispose of them.
When they accidentally release chemicals into the environment, they call Clean Harbors to help clean it up.
When they have waste oil, solvents, precious metals or paint, they call Clean Harbors to recycle.
The new report also highlights the vital role our employees play in our performance.
We strive to create a diverse and inclusive culture, one that values the unique backgrounds, perspectives and experiences of our people.
We are committed to building a sustainable culture through training programs that enable our employees to have -- to enjoy long and successful careers at Clean Harbors.
I encourage everyone to take a look through the report.
It provides the detailed picture of how closely intertwined sustainability is with our entire organization, culture and business model.
We ended 2020 on a high note with another strong financial performance.
If you asked me back in April, when the pandemic began, what level of revenue, adjusted EBITDA and adjusted free cash flow we would have delivered this year, these would have not been the numbers.
Our Q4 adjusted EBITDA results exceeded the guidance we provided in November.
Revenue declined 9% year-over-year, but was up in the third quarter despite Q4 typically being a sequentially lower quarter due to seasonality.
Our efforts to control costs and grow our highest margin businesses, combined with some further government program assistance, resulted in 180 basis point improvement in gross margin.
Adjusted EBITDA grew 3% to $136.1 million.
Our Q4 adjusted EBITDA margin rising 190 basis points from last year speaks to the effectiveness of the actions we have taken this year.
We have improved our adjusted EBITDA margins on a year-over-year basis for 12 consecutive quarters.
For the full year, our adjusted EBITDA margins grew 17.7% -- grew to 17.7%.
If you excluded the $42.3 million of government assistance, those margins would have been 16.3% or a 50 basis point improvement from 2019.
SG&A total costs were down in the quarter based on our lower revenue and cost controls.
But on a margin basis, we're essentially flat.
For the full year, SG&A as a percentage of revenue was 14.3%, which beat our target of 14.5%.
For 2021, using the midpoint of our guidance range, we would expect SG&A to be up in absolute dollars from the prior year and essentially flat on a percentage basis.
Depreciation and amortization in Q4 was down to $71.4 million.
For the full year, our depreciation and amortization was $292.9 million, which was within our expected range.
For 2021, we expect depreciation and amortization in the range of $280 million to $290 million.
Income from operations in Q4 increased by 18%, reflecting a higher gross profit, cost controls and mix of revenue.
For the full year, our income from operations rose 10% to $251.3 million.
Turning to slide 10.
We conclude the year with our balance sheet in terrific shape.
Cash and short-term marketable securities at December 31 were $571 million, up nearly $40 million from the end of Q3.
Our debt was at $1.56 billion at year-end, with leverage on a net debt basis at 1.8 times, our lowest level in a decade.
Our weighted average cost of debt is 4.2%, with a healthy mix -- healthy blend of fixed and variable debt.
With the recent revolver we put in place, we have no debt maturities until 2024.
Turning to cash flows on slide 11.
Cash from operations in Q4 was $113.2 million.
capex, net of disposals, was up slightly to $43.6 million.
That combination resulted in adjusted free cash flow in Q4 of $69.6 million.
For the year, we hit our net capex target, excluding the purchase of our headquarters, with $165.6 million of spend.
That helped us deliver record annual adjusted free cash flow of $265 million, which is toward the high end of our guidance range.
For 2021, we expect net capex in the range of $185 million to $205 million, which is higher than prior year.
Our net capex as a percentage of revenue ranks as one of the lowest among our specialty waste peers.
During the quarter, we increased the level of our share repurchases as we bought back 500,000 shares at an average price just under $71 for a total buyback of $35 million.
In 2020, we repurchased slightly over 1.2 million shares of our authorized $600 million share repurchase program, we have just under $210 million remaining.
Moving to guidance on slide 12.
Based on our 2020 results and current market conditions, we expect 2021 adjusted EBITDA in the range of $545 million to $585 million.
That amount in 2021 should be about $16 million to $18 million compared with $18.5 million in 2020.
Looking at our guidance from a quarterly perspective, we expect Q1 adjusted EBITDA using our revised definition to be 5% to 10% below prior year levels given the record Q1 results we posted in 2020 prior to the pandemic taking hold and the deep freeze we are experiencing in the Midwest and the Gulf here in February.
Here is how our full year 2021 guidance translates from a segment perspective.
In Environmental Services, we expect adjusted EBITDA to decline in the mid-single digits on a percentage basis from 2020.
We expect to benefit from growth and profitability within incineration, a rebound in the majority of our service businesses, along with our comprehensive cost measures, but not enough to fully offset the decline in high-margin decontamination work as well as the large contribution from government assistance programs in 2020 that totaled $27.1 million in this segment.
For Safety-Kleen, we anticipate adjusted EBITDA to increase in the mid- to high single digits on a percentage basis from 2020.
Despite the fact this segment received $12.2 million in government assistance last year.
We expect a mild rebound in the branch business weighted toward the second half of the year post vaccination.
At the same time, we expect SK Oil to deliver a vastly improved performance in 2020, given the current base oil industry supply dynamics as well as our ability to aggressively manage our rerefining spread and collect more gallons of waste oil.
In our Corporate segment, we expect negative adjusted EBITDA to be flat with 2020, which includes $3 million of governance assistance.
For 2021, our EBITDA guidance assumes receiving $2 million to $3 million of Canadian government assistance.
We are not assuming any additional CARES money in 2021 at this time, but we are reviewing the new program.
Based on our EBITDA guidance and working capital assumptions, we now expect 2021 adjusted free cash flow in the range of $215 million to $255 million.
We believe this puts us in a great position to execute on our capital allocation strategy.
In summary, although the pandemic is still with us, we entered the new year with strong momentum in multiple service businesses and most importantly, across our facilities network.
Industrial production in the U.S. is back on the rise by all indications, particularly in the chemical space.
The Chemical Activity Barometer, published by the American Chemistry Council, show that industry levels have been climbing sequentially from May to January, and January was the first time in 10 months that the activity levels were above the prior year, which is a great sign for us.
In addition, our rerefinery business is off to a great start, given the current market conditions.
We expect some of the project and turnaround work that was pushed out in 2020 to benefit us this year and the overall sales pipeline remains strong.
While we are seeing COVID cases decline sharply in recent weeks, we anticipate continued opportunities for near-term decontamination work and disposal of vaccination waste volumes.
Overall, the number of favorable industry and regulatory trends should support our business moving forward.
And while we don't give specific revenue guidance, we certainly expect aline growth in 2021.
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sees 2021 adjusted ebitda in range of $545 million to $585 million, based on anticipated gaap net income in range of $105 million to $146 million.
performance in quarter was again led by our environmental services segment, where we achieved better-than-expected results.
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We will start today's call with remarks from Bill Berry, Continental's Chief Executive Officer and Jack Stark, President and Chief Operating Officer.
Bill and Jack will be joined by additional members of our team, including Mr. Harold Hamm, Chairman of the Board; John Hart, Chief Financial Officer and Chief Strategy Officer; and other members of our team.
Finally, on the call, we will refer to certain non-GAAP financial measures.
I hope everyone is well.
This significant free cash flow is being dedicated to shareholder capital returns in the form of an increased quarterly dividend to $0.15 per share, continued focus on debt reduction and resumption of our $1 billion share repurchase program.
We appreciate our investors support and hope this continues to provide confidence in Continental being the best investment opportunity in the industry and the most shareholder return-focused company in any industry.
During the second quarter, we generated a company record-breaking $634 million of free cash flow, reducing net debt by $284 million ending the quarter with $4.59 billion.
Year-to-date, we've generated $1.34 billion in free cash flow, while reducing our net debt by $892 million.
We distributed $40 million to shareholders with our previous $0.11 quarterly dividend.
We exceeded our production guidance for the quarter, delivering 167,000 BOE a day and just over -- barrels of oil a day and just over 1 billion cubic feet of gas per day.
We delivered exceptional performance and efficiencies from our assets in the Bakken and Oklahoma, which Jack will provide more details.
With respect to hedging, we remain unhedged on crude oil.
On gas, we have about approximately 50% of our volume hedged through year-end with a combination of swaps and collars that provide a flow around three powertrain retaining price upsize of over $5.
For 2022, we have no gas hedges beyond the first quarter and no hedges at all in 2022.
While we remain bullish on commodity prices given the volatility of price cycles and potential impact of government reaction to COVID variants, we continue to believe it is inappropriate for the industry to overproduce into a potentially oversupplied market, particularly with respect to crude oil.
As I highlighted last quarter, we remain focused on our strategic vision with four key elements I'd like to briefly discuss today.
Free cash flow commitment and capital discipline, strengthening the balance sheet, and corporate and cash returns to shareholders.
Let me start with our commitment to free cash flow and capital discipline.
Our cash flow generation is robust and competitively advantaged versus our peers given our unhedged crude oil profile as shown in Slide 4.
In the first half of the year, we have year-to-date already generated the free cash flow we were projecting for the entirety of 2021.
We're announcing the potential to generate approximately $2.4 billion of free cash flow at current strip prices this year, which equates to an approximately 19% free cash flow yield.
Given our discipline response to rising commodity prices, our capex budget for 2021 has not changed and our reinvestment rate is trending toward 35%.
With regard to strengthening the balance sheet, our net debt reduction is tracking toward $1.8 billion in 2021, which will bring our year-end net debt close to $3.7 billion.
We expect to meet or exceed our leverage target of one-time net debt to EBITDA this year, but are not finished there.
Our intention is to reduce absolute debt to one-time at $50 to $55 WTI, which equates to approximately $3 billion in debt.
Alongside our strong inventory and commodity optionality, we are confident our net debt outlook is one of the many powerful attributes for both the company and our shareholders.
And we believe our current credit metrics are reflective of investment grade.
So let me now discuss corporate returns and cash returns to investors.
We're generating strong corporate returns and projecting to deliver 18% return on capital employed in 2021.
Additionally, we're committed to disciplined and significant shareholder returns through net debt reduction and prioritizing cash returns using the multiple vehicles we have to return cash to investors, including our dividends and share repurchases.
We're committed to growing our dividend in a competitive and sustainable manner.
That is why we increased our quarterly fixed dividend by 36% versus last quarter to $0.15 a share.
This has tripled our original dividend rate and equals to an approximately 1.7% annualized dividend yield, which we believe is competitive with industry peers and shows ongoing growth in cash returns.
We are resuming our share repurchase program of $1 billion, which began in 2019 with $317 million of purchases previously executed $683 million of capacity remains.
Given our significant shareholder alignment you can be confident that shareholder capital returns will remain a significant priority for our company.
The combined shareholder capital returns in the form of the annualized dividend and projected net debt reduction by year-end 2021 alone would equate to 53% of the company's projected full year 2021 cash flow from operations, and 16% of the current -- company's current capital market.
Share repurchases would be additive to these figures depending on the timing of additional share repurchases, which we expect to be in the near future.
2021 guidance updates, let me share with you a little bit on where we are on that.
As we look ahead to the remainder of 2021, several of our key metrics are materially outperforming our original guidance such that we have updated for the following.
Natural gas production in 2021 is now expected to range between 900,000,001 BCF a day.
Production expense is projected to be $3 to $3.50 per BOE better than the original guidance of $3.25 to $3.75.
Additionally, as reflected on Slide 16, we have improved our guidance on DD&A and crude and gas differentials.
I also want to highlight our continued focus on ESG.
We recently released our 2020 ESG updates, which can be found on our website, www.
ESG has always been a key part of our DNA and something we have highlighted as a means to steward our company.
Our ESG efforts remain focused on continuously improving and our approach is to look at all operational impacts, including land, water, and air.
We believe it is essential all countries and all economic participants do their part to improve the ESG in the same way, in order to better our world.
In closing, I did want to provide an update on the launch of the new futures contract Midland WTI American Gulf Coast, which will start trading on the Intercontinental Exchange by year end.
This is a combination of recommendations by the AGS Best Practices Task Force led by Harold Hamm, along with efforts by Magellan and Enterprise Products, and will be an exciting opportunity for U.S. producers seeking greater transparency, more liquidity, and access to global markets.
Appreciate you joining our call.
Today, I'm going to share some highlights from the outstanding results our teams delivered this quarter, and there are three key takeaways I want to leave you with.
First, our assets are performing with remarkable consistency and predictability, delivering their terms in excess of 100% from our Bakken and 60% to 80% from our Oklahoma drilling programs, assuming $60 WTI and $3 NYMEX gas.
Second, we are on track to reduce our weighted average cost per well year-over-year by approximately 10%, and 70% to 80% of these savings are structural.
Third, our capital efficiencies are reaching record levels and we expect to deliver a projected return on capital employed of approximately 18% for 2021.
Our assets also provide optionality to respond to changing market conditions.
For example, the decision to focus up to 70% of our rigs on our Oklahoma natural gas assets in the second quarter of last year has proven to be very strategic.
Our second quarter 2021 natural gas production in Oklahoma was up approximately 10% over the first quarter of 2020, while NYMEX natural gas prices, more than doubled over this same period of time.
With today's improved crude prices, we are exercising this optionality once again in migrating up to 75% of our rigs to a more oil weighted portfolio in the back half of this year.
As Bill highlighted, our well production remains unhedged and our shareholders are receiving the full benefit of the improved crude oil price.
So let's get into the quarterly highlights.
During the quarter, we brought on 108 gross operated wells with 70 in the Bakken and 38 in Oklahoma.
Early performance from our 2021 Bakken wells is right on track as shown on Slide 8.
This chart compares the average performance of our 2021 wells with average performance of 488 Continental operated wells completed over the prior four years, grouped by program year.
Over the last four years, we have also reduced our cycle time for putting Bakken wells online by 50% and dropped our completed well costs by approximately 30% driving our capital efficiencies in the Bakken to record levels.
Today, we are producing approximately 45% more BOE per $1,000 spent in the first 12 months than we did in 2018.
Our Bakken differentials are also improving, driven by demand for Bakken crude and the expansion of DAPL, which was put into operation on August 1.
With this expansion, there is approximately 1.6 million barrels of pipeline and local refining takeaway capacity from the Bakken excluding rail.
Bottom line, considering all of these improvements and the bullish market fundamentals, we are potentially entering one of the most profitable chapters in the history of the Bakken for Continental and its shareholders.
Before leaving the Bakken, I should point out that 11 of our second quarter Bakken completions were located in our Long Creek unit.
These 11 wells are excellent producers as shown on Slide 9, equally impressive by the well costs that are coming in below original estimates at approximately 6.1 million per well.
Recent results are bellwether for things to come, as we continue developing a total of 56 wells in this unit, and we expect to complete about 30% of these wells by year-end 2021, 50% in 2020 and the remaining 20% in early 2023.
In Oklahoma, we continue to see excellent results from our really both our oil and gas condensate wells as illustrated on Slide 10.
These charts show the average well performance by year in all four of our SpringBoard project areas over the last 2.5 years.
The SpringBoard I -- in SpringBoard I and II, you can see that the average well performance has improved over time with great repeatability in both the condensate and oil windows.
This includes 155 operating wells of which 70% were oil well and 30% were condensate wells.
Now the chart on the lower left of Slide 10 shows impressive performance from our operated oil wells in SpringBoard III and IV.
This is a small dataset, so we chose to break the average annual performance by producing formation to provide more color on the results we have seen to-date.
The chart includes seven Woodford and four Sycamore wells that we completed over the last 2.5 years.
The key observations from this chart is that the seven Woodford wells are performing in line with SpringBoard I and II oil wells, while there is four Sycamore wells that were completed in 2019 are significantly outperforming.
Even more impressive is that we're on track to reduce our completed well cost by approximately 17% year-over-year.
Since 2018, our teams have reduced completed well costs in Oklahoma by a total of 40%, which as in the Bakken has driven our capital efficiencies to record levels in Oklahoma.
As shown on Slide 11, we are producing approximately 80% more BOE per $1,000 spent in the first 12 months than we did in 2018.
In the Powder River Basin, our drilling is proceeding right on schedule.
Our drilling teams are doing a great job and have met and exceeded our early expectation for drilling days and costs.
We have six wells waiting on completion and expect to have some results to share later this year.
We currently have two rigs drilling through year end.
Looking ahead, we are maintaining our oil production guidance for the year, and I should point out that our second quarter production was boosted by accelerating the completion of select third quarter wells and putting them online in the second quarter.
In the fourth quarter, we are projecting a December exit rate of approximately 165,000 barrels of oil per day.
We currently have eight rigs drilling in the Bakken, two in the Powder and five in Oklahoma, and are considering adding up to one rig in the Bakken and two in Oklahoma by year end.
In closing, I'll mention that our exploration teams at Continental continue to generate new opportunities within and outside of our core operating areas.
Later this year, we plan to do some exploratory drilling to test a couple of these new opportunities.
Details must remain confidential, but I can tell you that with success, each of these opportunities could add significantly to our deep inventory.
So with that, we are now ready to begin the Q&A session -- section of our call.
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increased its 2021 annual natural gas production guidance to 900 to 1,000 mmcfpd.
continental resources - now projects generating $3.8 billion of cash flow from operations, $2.4 billion of free cash flow for 2021 at current strip prices.
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We will start today's call with remarks from Bill Berry, Continental's Chief Executive Officer; John Hart, Chief Financial Officer and Chief Strategy Officer; And Jack Stark, President and Chief Operating Officer.
Additional members of our senior executive team, including Mr. Harold Hamm, Chairman of the Board, will be available for Question and Answer.
Finally, on the call, we will refer to certain non-GAAP financial measures.
I hope moving the earnings date was not an inconvenience for any of you.
We did this to be able to share several exciting things with you today.
First, is our record free cash flow for the quarter of $669 million.
Clearly, 2021 is going to be a record year for us in terms of free cash flow generation.
Second, we have expanded both our shareholder capital and corporate returns.
This includes increasing our dividend by 33% from $0.15 to $0.20 per share with our return on capital employed and increasing to approximately 21%.
Third, is the exciting news that we now have strategic positions in four leading basins across the Lower 48 with a $3.25 billion acquisition of Delaware assets from Pioneer, providing our company and shareholders with material, geologic and geographic diversity.
Like our first quarter Powder River Basin acquisition, this transaction is accretive on key financial metrics, and the acquired assets will complement our existing deep portfolio in the Bakken, Oklahoma and Powder River.
And fourth, we are now post this transaction, we have been fully returned to fully investment grade.
And as we've indicated on previous calls, we believe Continental has more alignment with shareholders than any other public E and P company.
We focus every day on maximizing both shareholder and corporate returns.
The Permian Basin acquisition will be an integral contributor to these shareholder return plans.
This is an outstanding asset with 92,000 acres, over 1,000 locations, 50,000 net royalty acres.
The acquisition also comes with about 55,000 BOE per day from PDP and anticipated volumes from wells in progress.
And finally, and possibly most importantly, this Permian transaction is projected to add up to 2% to our return on capital employed annually over the next five years.
The acquisition of these assets strongly supports the tenants of Continental's shareholder return on investment and return of investment, dividends and share repurchases.
These are all driven by a continued commitment to strong free cash flow.
Our plans for low single-digit production growth are the foundation for being able to deliver strong free cash flow.
During the third quarter, we took additional steps to increase returns to shareholders with our third dividend increase in as many quarters and executing on $65 million in share repurchases.
While we will be taking on some additional debt to pay for the transaction, our net debt-to-EBITDAX target remains the same, less than one.
We expect to exit this year at a quarter annualized net debt-to-EBITDA of about 1.3 and expect to be below 1-0 1.0 by year-end 2022, assuming $60 and strip gas pricing.
We are unwavering in our commitment to reduce debt.
Our 2021 cash flow generation remains very competitive versus our peers in the broader market, as shown on Slide seven.
This is even after our stock has nearly tripled year-to-date.
We see the potential to generate $2.6 billion of free cash flow this year, which equates to about 14% free cash flow yield at current prices.
This is significantly above the majority of our industry peers and the broader market, indicating further upside in the value of our stock.
As we look to 2022, we expect to provide updates on capital budget and operations, including the pending integration of our newly acquired Permian assets early next year.
We are confident this acquisition will further enhance our free cash flow generation.
Our ESG performance is top of mind for me, and I want to update you with regards to our ESG performance year-to-date.
In the third quarter, we achieved a 98.9% gas capture rate, up from 98.3% in 2020.
In support of our industry-leading ESG gas capture stewardship, we have deferred approximately $45 million in revenue in 2021.
Additionally, we have achieved zero recordable injuries among our employees, through the third quarter 2021.
Congratulations to the team on an outstanding performance.
We're proud of our teams and their exceptional commitment to continuously operate with integrity in a safe and environmentally responsible manner.
We'll spend the remainder of the call discussing some of the specifics on our recently announced and highly accretive expansion into the Permian Basin.
John will highlight the compelling financial aspects of our expansion, and Jack will provide details regarding the outstanding geologic attributes and fully integrated nature of the deal.
Our new position in the Permian as shown on Slide four, was driven by our geology-led corporate strategy and is built on a strong foundation of geoscience and technical operation skills, coupled with the management team fully aligned with shareholders.
This transaction increases Continental's operational footprint in the area with our current acreage position across the Permian now approximately 140,000 net acres.
Later on the call, Jack will provide details regarding this expanded Permian footprint, along with the tremendous success our teams have had growing our top-tier corporate portfolio of Lower 48 assets.
Approximately, 75% of the price of this asset is covered by PDP value and wells in progress at current strip prices, leaving significant upside value and undeveloped acreage.
On a pro forma basis and at current strip prices, we expect to generate at least $3 billion of cash flow in 2022.
Our pro forma free cash flow in '22 is projected to be about 17%.
This compares very favorably to our 2021 projected free cash flow yield of about 14%.
Like our other assets, the fully integrated nature of this asset offers a multifaceted value proposition including minerals and water infrastructure that we control and provides tremendous optionality and upside in the future, as shown on Slide four.
The transaction has been unanimously approved by the company's Board of Directors and is effective as of October 1, with an expected closing date in the fourth quarter.
As Bill mentioned, today's acquisition is immediately financially accretive on cash flow and free cash flow per share, earnings per share, return on capital employed and cash margin.
This transaction has a number of benefits to Continental shareholders.
Let's discuss a few of those items.
This transaction is credit-enhancing due to projected cash flow and rapid debt paydown benefiting our credit metrics while enhancing our commodity optionality and geographic diversity.
It is beneficial to the ongoing trajectory of our credit rating.
I will discuss agency views momentarily.
This transaction includes a healthy amount of PDP, benefiting our EBITDAX by approximately $900 million per year at current strip prices, enhancing our credit metrics.
Additionally, we are projecting an incremental $500 million of free cash flow from the acquired asset in 2022 at current strip prices based on estimated '22 production and capital spending.
Combined with our legacy assets, we expect 2022 free cash flow of at least $3 billion at strip prices for Continental.
We have significant flexibility in how we plan to finance the transaction.
As of September 30, we had approximately $700 million of cash on hand with expectations for strong free cash flow moving forward.
Our revolver remains fully undrawn.
On October 29, we extended our revolver maturity to October 2026.
And increased available commitments to $1.7 billion.
We intend to utilize available cash and our revolver to fund a significant amount of this transaction.
Remaining acquisition financing will be derived from debt capital markets and/or bank term facilities.
We will not issue additional equity as a means to fund this deal.
This financing approach amplifies the accretive nature of this transaction on a per share basis.
Our credit metrics also remained strong with net debt to EBITDAX projected to increase only slightly from 0.9 times in the third quarter to 1.3 times initially with the transaction but is expected to drop below 1 times during 2022 at current strip prices.
Our target is to reduce net debt back to current levels or approximately $4 billion by year-end '22.
We plan to utilize 2022 cash flow to pay off the revolver funding, rebuild our cash position and pay off our '23 and '24 bond maturities at the earliest possible opportunity.
As you may have noted, the rating agencies have been supportive of this transaction and our plans.
Fitch has upgraded us to BBB.
Moody's has upgraded us to Baa3 and S and P has maintained a positive outlook to upgrade to IG.
This positions us with two agencies at investment grade, making us fully investment-grade eligible, and one agency with a positive outlook to investment grade.
We are pleased with this progress as our objective is three investment-grade ratings.
As we have discussed in previous quarters, and as you will note in the Form 10-Q with the rise in natural gas prices, the company has elected to lock in a portion of associated cash flows through natural gas hedges at attractive prices.
Subsequent to September 30, we have continued to layer in natural gas hedges for the second quarter of 2022 through year-end 2023.
We've utilized a combination of swaps and collars with an average swap of $371 and an average foot of $325 at an average collar of $496.
These positions are summarized in our 10-Q along with our prior positions.
We are largely in hedged for oil, as we believe market fundamentals are supportive of price participation due to supply and demand rebalancing.
We have remained capital disciplined with a projected reinvestment ratio of approximately 40%.
Reflecting back on our original guidance in February, we were projecting at that time, $1 billion of free cash flow with a reinvestment rate of 58%.
With our free cash flow now up approximately 160% from our original guidance, we have decided to reinvest a modest amount of additional capital this year or just under 10% of that incremental cash flow figure.
This is due to the associated capex from the pending Permian acquisition, additional leasehold acquisitions and incremental gas-focused activity in order to meet domestic and global natural gas consumer demand, given an undersupplied market outlook this winter.
I'll start out by saying that the Permian assets we acquired are excellent addition to our existing portfolio.
They contain the key strategic components common to all of Continental's assets, including the right rocks, excellent economics, a significant contiguous acreage position with high working interest and net revenue interest, mineral ownership, surface ownership, operated water infrastructure and significant upside potential through continued operating efficiencies, technology and exploration.
I'll touch on each of these briefly here.
First and foremost, it's all about the rocks.
Referring to Slide four, these assets contain proven, stacked oil-rich reservoirs as well as other high potential reservoirs we intend to explore and develop in the future.
We estimate that these assets contain an inventory of over 650 gross wells targeting three primary reservoirs, including the third Bone Spring, the Wolfcamp A, Wolfcamp B, and we think there are over 1,000 locations when you consider other known producing reservoirs that underlie this acreage.
On an economic basis, these assets complement our existing inventory very well delivering rates of return from 50% to well over 100% at $60 WTI and $3 NYMEX.
The 92,000 net leasehold acres being acquired are largely contiguous, as you can see on Slide four and highly concentrated.
Continental will operate 98% of this acreage with an average working interest of approximately 93% per well, and over 90% of this acreage is held by production.
The acquisition also includes 50,000 net royalty acres.
Approximately 70% of these royalty acres directly underlie our leasehold, which raises the average net revenue interest for wells drilled on this acreage to around 80%.
The acquisition also includes significant water infrastructure and surface ownership, including 31,000 surface acres, approximately 180 miles of pipeline, water facilities and disposal wells that can be expanded to accommodate growth.
This will provide immediate operating efficiencies and cost benefits to our operations.
The acquisition also includes approximately 55,000 BOE per day of production, which is inclusive of 10 wells in progress on a pro forma basis, and approximately 70% of this production is oil.
The last point I'll make on these assets is that they are in the early stage of development, which is exactly what we like.
The initial phase of testing and reservoir delineation is complete and the properties are teed-up for full field development.
And as in all of our plays, we see significant opportunity to improve well performance and financial returns through optimized density and wellbore placement, operational efficiency gains and asset growth through exploration.
Most importantly, we've expanded our operations into two additional world-class oil-weighted basins, the Powder River Basin and Permian Basin.
Through Grassroots leasing, trades and strategic acquisitions, we now own or have under contract approximately 140,000 net acres in the Texas portion of the Permian Basin and approximately 215,000 acres -- net acres in the Powder River Basin.
During this time, we also expanded -- or we also added approximately 47,000 net acres in the heart of our springboard assets in Oklahoma.
Combined, these assets have tremendous resource potential, adding well over one billion barrels of net resource potential to our industry-leading assets in the Bakken and Oklahoma, providing Continental shareholders a deep and geologically diverse oil-weighted inventory that will drive strong returns and profitability for decades to come.
This company has a long well-established track record of having an exceptional capability of transferring our unique geologic and operational expertise to new and existing basins.
We have created significant inflection points for the company in the past with our entry into the Bakken and Oklahoma positions.
We now see our position in the Permian and Powder River as an additional inflection point, representing significant complementary step changes to the company's portfolio.
With that, we're ready to begin the Questions and Answers section of the call.
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delivering record free cash flow & strategic expansion into permian basin.
$1.20 per adjusted share (non-gaap)) in 3q21.
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On a consolidated basis, the company reported net sales for the second quarter of $406 million and adjusted EBITDA of $15 million.
A few highlights to mention.
Our Paperboard business continued to see strong demand.
Based on that strong demand, we implemented previously announced price increases across our SBS portfolio.
We successfully completed our largest major maintenance outage of 2021 in April at our Lewiston, Idaho mill, which impacted the business by $22 million.
As previously discussed, our tissue business saw lower shipments, reflecting market trends.
Consumers destock their pantries and retailers work through elevated inventory levels.
Both industry data and our own sales orders point to a bottoming out of shipments in April.
We started seeing a recovery in May.
With the decrease in orders and elevated pull price levels, we took downtime on our tissue assets to meet demand and reduce inventories, which impacted our fixed cost absorption.
We also announced an indefinite closure of Anina Wisconsin tissue mill and an exit from the away-from-home tissue market.
These actions will result in a lower overall cost structure of our tissue business.
In comparing the first quarter to second quarter 2021 raw material inflation was largely offset by the previously announced price increases in SBS and mix.
And finally, we maintained ample liquidity of $297 million at quarter end and reduced net debt by $4 million.
As noted during previous quarters, we remain focused on our top priorities during COVID, the health and safety of our people and safely operating our assets to service customers.
We're monitoring the latest trends and are adjusting protocols and policies to keep our people safe.
Let's discuss some additional details about both of our businesses.
As you recall, we estimate that approximately 2/3 of paperboard demand is derived from products that are more recession-resilient and 1/3 is driven by more economically sensitive or discretionary products.
We continue to experience strong demand from our folding carton customers, and a recovery in food service segments.
Demand for food packaging products and retail paper place has remained healthy throughout the pandemic.
We're also pleased with the market reception of our sustainability focused brands with NuVo Cup and ReMagine folding carton.
Both are playing a role in our favorable market position and our order books continue to be robust.
We are diligently working to implement the previously announced price increases.
Since the beginning of this year, Fastmarkets RISI, a third-party industry publication recognized price increases that totaled $130 per ton in folding carton and $100 per ton in cup, including the latest increases in July of $30 per ton in folding and $50 per ton in carton.
Typically, it takes us up to two quarters before realizing most of these price changes in our financials.
We will discuss the estimated impact to our 2021 results later in our comments.
We completed our largest planned maintenance outage for 2021 during the second quarter.
The economic impact from this outage to our adjusted EBITDA was $22 million, within our previously discussed range of $21 million and $24 million.
Our industry view remains largely the same.
The market for tissue in the U.S. is traditionally 2/3 at home and 1/3 away from home with around 10 million tons per year of total demand.
As consumers spend more time at home in 2020, there was a shift toward at-home consumption.
Throughout the pandemic, we witnessed consumer pantry loading and retailers responding by placing higher orders with existing suppliers and seeking out tertiary suppliers, both domestic and international to need demand.
We believe that this could have led to more than a month of excess inventory in the supply chain by the end.
Let me share some data in context pertaining to demand trends that we witnessed in the first half of this year.
Consumers started to return to a more normal lifestyle in Q1 and Q2 as vaccines were becoming available and restrictions were being eased.
This led to a reduction of at-home tissue purchases and destocking of consumer pantries.
Based on IRI market data, consumer purchases based on dollar sales bottomed out in March.
Due to these consumer trends, retailers were faced with higher inventories in Q1 and into Q2.
In response, they reduced orders to manage their inventories.
Based on Fastmarkets RISI data, retailer shipments of finished goods bottomed out in April.
This is consistent with our order patterns.
Both external data and our own internal order patterns are indicating that we're in a demand recovery period, which we believe will continue for balance of the year.
We believe the industry's long-term trends are healthy, and we expect continued growth in overall consumption and private brands continuing to gain share.
Let me provide some additional detail on our tissue volume trends.
We shipped 10.2 million cases in the second quarter, which was down approximately 36% and 13% compared to the second quarter of 2020 and first quarter of 2021, respectively.
Our low point for shipments was 3.1 million cases in April.
Since then, we've had more month-over-month growth in May and June.
We expect this improvement trend to continue throughout the fourth quarter.
We're also closely monitoring channel and customer trends to ensure that we're aligned with areas in the market with the highest long-term growth potential.
To adjust to reduce demand, high inventory levels and high coal prices, we took significant asset downtime in the second quarter, which negatively impacted our profitability.
We will continue to manage our production levels in Q3 and Q4 to service demand reduce inventory and minimize cost.
Additionally, in the second quarter, we announced the indefinite closure of our Neenah, Wisconsin site with production ceasing in July.
While our people in Neenah operated a site well, the assets were not economically viable.
Retail volume from Neenah is being shifted to other lower-cost facilities, such as our Shelby, North Carolina mill.
By closing Neenah, we're also exiting the away-from-home market, where we had a small and subscale position.
While the decision was the right one for the business, it is difficult on our people and in the community.
The consolidated company summary income statement shows second quarter 2021, the second quarter of 2020 and the first half of each year.
In the second quarter of 2021, our net loss was $52 million.
Diluted net loss per share was $3.10 and adjusted loss per share of $1.07.
The adjustments incorporate the impacts from the Neenah site closure as well as other adjustments.
The impact of the Neenah aclosure activities in the quarter was $41.7 million.
The noncash portion of the charge, $36.9 million was primarily a fixed asset impairment, but also included inventory and other reserves.
The cash portion of the charge was for employee pay during a worn notification period and severance-related expenses of $4.9 million.
We anticipate that we will have similar employee-related cash expenses in the third quarter, slightly above $4 million.
These estimates reflect our best assessment at this time, and we will update them as appropriate as we monetize the assets at Neenah.
The corresponding segment results are on slide seven.
Our Paperboard business completed a major maintenance outage in the second quarter of 2021 that impacted us by $22 million, while consumer products saw lower production and demand.
In our comments during the second quarter, we mentioned that our adjusted EBITDA could be close to breakeven for the second quarter of 2021 relative to the first quarter of 2021 adjusted EBITDA of $54 million.
With $15 million of adjusted EBITDA for the second quarter, we came in better than our initial expectations.
The improved performance relative to expectations included the impact of the Neenah closure better tissue demand, cost mitigation efforts and better SBS price realization.
Slide eight is a year-over-year adjusted EBITDA comparison for our Pulp and Paperboard business in the second quarter.
We have and are continuing to implement the previously announced price increases as well as experiencing some positive mix benefits with similar sales volumes as last year.
Our costs were impacted by the major maintenance outage of $22 million as well as inflation in raw material inputs and freight.
You can review a comparison of our second quarter 2021 performance relative to first quarter 2021 performance on slide 14 in the appendix.
Price and mix were a limited part of the story for tissue.
Our sales of converted products in the second quarter were 10.2 million cases, representing a unit decline of 36% versus prior year.
Our production of converted product in the quarter was 9.6 million cases or down 40% versus the prior year.
With the actions that we took at Neenah, drawdown of inventory and lower incentive comp accruals in SG&A, we were able to partially offset some of the raw material inflationary headwinds.
We anticipate the financial impact from raw material inflation will increase in the coming quarters.
You can review a comparison of our second quarter 2021 performance relative to the first quarter of 2020 on slide 15 in the appendix.
We also have finished goods production and other financial data on a quarterly basis on slide 16 for both businesses.
Slide 10 outlines our capital structure.
Our liquidity was $296.5 million at the end of the second quarter.
With the cash flow headwinds of the second quarter behind us, we believe we will generate more free cash flow in the back half of 2021 to further reduce our net debt.
Maintenance financial covenants do not present a material constraint on our financial flexibility, and we do not have near-term debt maturities.
Slide 11 provides a perspective on our third quarter outlook and other key drivers for full year 2021.
Our expectations assume that we continue to operate our assets without significant COVID-related disruptions.
As previously discussed, demand visibility in tissue as well as inflation expectations have and will continue to be unpredictable.
I would like to focus my comments for the third quarter expected adjusted EBITDA of $40 million to $48 million and build up to that range from our second quarter adjusted EBITDA of $15 million.
The planned major maintenance outage at Lewiston in April is behind us with a negative impact of $22 million.
And we recently completed the planned outage at Cypress Bend this past weekend with an anticipated impact of $3 million to $5 million.
The difference of the adjusted EBITDA impact between the second and third quarters resulted in an expected increase of adjusted EBITDA of $17 million to $19 million.
Previously, announced SBS pricing is expected to positively impact us during the quarter by $9 million to $11 million.
We estimate that raw material cost inflation will negatively impact our business by $9 million to $13 million in the third quarter relative to the second quarter.
When comparing the second quarter to our expectations for the third quarter, we believe that our previously announced SBS price increase could largely offset raw material inflation.
Tissue shipments are expected to grow by 10% to 15% relative to the 10.2 million cases shipped in the second quarter.
We shipped 3.7 million cases in July relative to our average monthly shipments of 3.4 million in the second quarter and our low point of 3.1 million cases in April.
The recovery in tissue shipments is occurring, and we expect it to continue through the rest of 2021.
As we expect to reduce inventories, we anticipate production being slightly below demand.
With the closure of Neenah, we are exiting the away-from-home tissue business, which was approximately 100,000 to 150,000 cases per month and will mildly impact our converted shipment volume trend lines and comparisons.
We will also receive the benefits during the third quarter from the Neenah closure.
While we are not providing specific annual guidance for 2021, there are several drivers, assumptions and variables we'd like to provide to you with an update relative to 2020.
We are expecting continued positive impact from the previously announced SBS price increases were expected to result in year-over-year benefits of $40 million to $45 million.
In our Paperboard business, planned major maintenance outages are expected to reduce our earnings for 2021 compared to 2020 by $25 million to $27 million, which is down from our previous guidance.
We are moving our head box project at Lewiston from the third quarter of 2021 into 2022 to accommodate our strong paperboard demand.
We have updated our guidance, including some adjustments to 2022 on slide 20, which reflects our current plan.
Our current view can -- is that our tissue volume decline year-over-year will be above 20%, which is not adjusted for the impact of our exit from the away-from-home business.
In total, from 2020 to 2021 input cost inflation, including pulp, packaging, energy, chemicals and freight is expected to be $60 million to $70 million relative to our previous estimate of $65 million to $75 million.
The majority of this inflation is in pulp.
The Neenah site recently generated negative adjusted EBITDA.
And by closing the site, we will avoid these losses and lower our overall cost structure by moving production to other sites.
These actions will also help realize the benefits of the Shelby investment.
In total, the benefit on a combined basis is expected to exceed $10 million annually with full benefit realization occurring in the fourth quarter.
For the full year 2021, we are also anticipating the following: we expect interest expense between $36 million and $38 million; depreciation and amortization between $104 million and $108 million; capital expenditures between $50 million and $55 million, which is slightly lower than prior expectations; and our effective tax rate is expected to be slightly higher than previous expectations at 26% to 27%.
I would like to reiterate my comments from last quarter regarding the actions that we're taking across the company to proactively address our market-driven headwinds and tailwinds.
In our Paperboard business, we're benefiting from the implementation of previously announced price increases and are maximizing production to meet demand.
This includes moving some maintenance and a head box installation from 2021 to 2022.
In our tissue business, we're working with customers to offset higher costs through product and other changes.
In addition to the market recovery in tissue demand, we're focused on growing our volume through various sales initiatives that have been discussed in previous quarters.
Across both businesses, we're taking steps to reduce both short- and long-term costs.
As previously discussed, we continue to focus on generating cash to reduce our net debt.
Last quarter, I spoke about performance improvement efforts focused on improving core operations in the medium to long term, aimed at achieving the full profit potential of Clearwater Paper over the next several years.
Given the inflation and competitive pressures in our industry, we are working to find ways like this effort to combat margin compression and achieve margin expansion.
We're in the planning phases currently, and I look forward to updating you when we're in the execution phase.
Let me remind you of why I think these businesses are well positioned in the long run.
For our Paperboard division, we believe that the key strengths of this business are the following.
First, we operate well-invested assets with a geographic footprint, enabling us to efficiently service our customers.
We have a diverse customer base, which serves end markets that have largely stable demand.
Second, not being vertically integrated enables us to focus on independent customers with unparalleled service and quality commitment.
Third, we will lead to product and brand development, the business is well positioned to take advantage of trends toward more sustainable packaging and food service products.
Lastly, our Paperboard business has demonstrated an ability to generate good margins and solid cash flows.
Our Consumer Products division is a leader within the growing private branded tissue market.
From our vantage point, we believe the key strengths of this business are the following.
First, we have a national footprint with an ability a wide range of product categories and quality tiers, which is an attractive sales proposition to our customers.
Our expertise in manufacturing, supply chain and transportation is a key differentiator.
Second, there are long-term trends away from branded products to private brands.
Private brand tissue share in the U.S. rose to over 30% recently, up from 18% in 2011.
While these trends are impressive, we're still a long way from where many European countries are where private brands represent over half of total tissue share.
Lastly, tissue is an economically resilient and need-based product.
Historically, demand has not been negatively impacted by economic uncertainty.
After we get beyond the COVID-related distortions in the market, we're optimistic that this business will generate meaningful cash flows over the long run.
We're committed to improving our business to be successful both in the near and long term, and we believe that we will come out of 2021 a better and stronger operation than where we started.
Our balance sheet is well positioned to support us with strong liquidity, limited financial maintenance covenants and debt maturities, which are a few years away.
We're again with our Board to develop a medium- to long-term capital allocation plan.
We look forward to sharing more on these ideas, which include internal investments, external investments and return of capital to shareholders as we get closer to our 2.5 times target leverage ratio.
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q2 loss per share $3.10.
q2 adjusted non-gaap loss per share $1.07.
q2 revenue $406 million versus refinitiv ibes estimate of $420.7 million.
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Joining me on the call today are Arsen Kitch, President and Chief Executive Officer; and Mike Murphy, Chief Financial Officer.
Financial results for the third quarter of 2021 were released shortly after today's market close, along with the filing of our 10-Q.
On a consolidated basis, the company reported net sales of $450 million, adjusted net income of $9 million, and adjusted EBIT of $50 million.
A few highlights to mention, our paperboard business continue to see strong demand.
Based on that demand, we implemented previously announced price increases across our SBS portfolio.
As per our expectations, we saw improving trends and tissue orders and shipments.
We completed the last of our major maintenance outages for the year at our Cypress Bend, Arkansas terminal.
We also completed the closure of the high cost Neenah tissue mill and our exit from the away-from-home tissue segment.
We saw accelerating inflation across both of our businesses, particularly in energy, chemicals, wood fiber and transportation, as pulp reached its peak and started to ease.
And finally, we maintained ample liquidity of $270 million at quarter end and reduce net debt by another $7 million.
As noted during previous quarters, we remain focused on our top priorities during COVID, the health and safety of our people and safely operating our assets to serve as customers.
We're monitoring the latest trends and are adjusting protocols and policies to keep our people safe.
Let's discuss some additional details about both of our businesses.
The industry continues to experience strong backlogs even with a higher SBS pricing that has been reported by Fastmarkets RISI, the third-party industry publication.
We have benefited from these industry dynamics and previously announced price increases.
Since the beginning of this year, Fastmarkets RISI has reported price increases for the US market that totaled $250 per ton in folding carton and cardstock.
This includes a $50 per ton increase in October for both grades.
We'll continue to see strong demand from our folding carton customers and a recovery in the foodservice segments.
We're also pleased with the reception of our sustainability focused brands of NuVo cup and ReMagine folding carton.
Both are helping our customers differentiate themselves in the market.
It typically takes us a couple of quarters for price changes to be fully reflected in our financials.
It is also worth noting that our portfolio includes additional grades and price mechanisms that are not reflected in RISI's reporting.
We will discuss the estimated impact of our previously announced pricing to our 2021 financials later in our comments.
Finally, we completed a planned maintenance outage at our Cypress Bend, Arkansas mill during the third quarter.
The financial impact from this outage to our adjusted EBITDA was $5 million.
We continue to operate in a difficult market environment.
As previously discussed, COVID led to significant volatility in tissue demand and retailer behavior in 2020 and 2021.
With that said, let me provide you with our point of view on the overall market.
In North America, we view tissue demand as being approximately 10 million tons with annual demand growth of 1% to 2%, slightly exceeding population growth.
Pre-COVID, the market was about two-thirds at home and one-third away from home.
Using that math, the at home market is six million to seven million tons, of which approximately two-thirds is branded and one-third is private branded.
We operate in the private branded market, which is approximately two million tons and has grown more quickly than the branded market.
In terms of the retailer, environment, clubs and the mass merchandisers have gained share at the expense of traditional grocers over the years.
As a reminder, we have greater exposure to grocery than the overall market.
In terms of supply, tissue capacity additions have primarily targeted the private branded space with capacity growth exceeding demand growth.
To the best, we believe that private branded manufacturers will operate a depressed capacity utilization levels in the next several years.
Let me share some context pertaining to demand trends that we witnessed in the first nine months of the year.
Consumers started to return to a more normal lifestyle in the first half of the year, as vaccines were becoming available and restrictions lessened.
This led to a reduction of at home tissue purchases and destocking of consumer pantries.
Based on IRI market data, consumer purchases measured in dollars bottomed out in March.
Due to these consumer trends, retailers were faced with higher inventories in the first quarter and into the second quarter.
In response, they reduced orders to manage their inventories.
Based on RISI data, retailers shipments of finished goods bottomed out in April.
This is largely consistent with our order patterns.
We observed demand recovery at the retailer level throughout the third quarter.
There was a demand uptick in August, related to the emergence of the Delta variant that led to higher orders than we anticipated.
September order patterns return to more normal levels, but we observed another uptick in orders in late October.
This volatility is a reminder of the unpredictable nature of our market during COVID.
Let me provide some additional detail on our tissue volume trends.
We ship 12.3 million cases in the third quarter, a 21% increase from the 10.2 million cases shipped in the second quarter.
This was a bit higher than our guidance of 10% to 15% growth, partly driven by the August demand uptick.
We expect demand to be flat in the fourth quarter relative to the third quarter.
But there's a high degree of uncertainty in consumer and retailer behavior as we head into the holidays.
We will continue to selectively take asset downtime as needed to manage inventories and our cost structure, particularly while coal prices are at elevated levels.
The consolidated company summary income statement shows third quarter 2021 -- the third quarter of 2020 in the first nine months of each year.
In the third quarter 2021, our net income was $2 million, diluted net income per share was $0.11, and adjusted net income per share was $0.55.
The adjustments incorporate the impacts from the Neenah mill closure as well as other adjustments.
The impact of the Neenah closure activities in the quarter was $5.4 million, which was related to severance and related expenses.
Corresponding segment results are on slide seven.
Slide eight is a year-over-year adjusted EBITDA comparison for our Pulp and Paperboard business in the third quarter.
We benefited from our previously announced price increases and a mild mix improvement with similar sales volumes as last year.
Our costs were impacted by $5 million of major maintenance outage expenses, and higher inflation and maintenance expenses.
You can review a comparison of our third quarter 2021 performance relative to second quarter 2021 performance on slide 14 in the appendix.
Price/mix were a limited part of the story for tissue.
Our sales have converted products in the third quarter were 12.3 million cases representing a unit decline of 15% versus prior year.
Our production of converted product in the quarter was 11.4 million cases are down 25% versus the prior year.
Please note that we largely exited the away from home tissue segments in the third quarter of this year, which historically represented 3% to 4% of our overall case volume.
While inflation pressure was significant, the action that we took it at Neenah helped offset some of the higher costs that we face.
You can review a comparison of our third quarter 2021 performance relative to second quarter of 2021 on slide 15 in the appendix.
We also have finished other operational and financial data on a quarterly basis on slide 16 for both businesses.
Slide 10 outlines our capital structure, our liquidity was $270 million at the end of the third quarter.
During the third quarter, we reduced net debt by $7 million.
Maintenance financial covenants do not present a material constraint on our financial flexibility.
And we do not have near-term debt maturities.
We've continued to target the net debt to adjusted EBITDA ratio of 2.5 times, which we expect to achieve by 2023.
Slide 11 provides a perspective on our fourth quarter and full year 2021 outlook the key drivers.
Our expectations assume that we continue to operate our assets without significant COVID related disruptions.
As previously discussed, demand visibility and tissue, as well as inflation expectations have and will continue to be unpredictable.
But that said, our expectation for the fourth quarter is adjusted EBITDA of $48 million to $56 million.
Let me walk you through the build up to that range from our third quarter adjusted EBITDA $50 million.
Previously announced SBS prices is expected to positively impact us during the quarter by $7 million to $9 million which is helping to offset inflation.
Raw material and freight cost inflation is expected to negatively impact us by $7 million to $12 million.
There are no planned major maintenance outages, which will benefit us, given the $5 million Q3 outage.
Tissue shipments are expected to be flat, while we take additional asset downtime to manage inventories.
We are expected to achieve the full run rate benefit of the Neenah closure, which we previous previously stated as being more than $10 million annualized.
If we take actuals for the first nine months and add our expectations for the first quarter, we expect adjusted EBITDA of $167 million to $175 million for the full year 2021.
We wanted to comment on some of the key drivers for 2021 relative to 2020.
We are expecting continued positive impact from previously announced SPS price increases, which are expected to result in year-over-year benefits of $53 million to $55 million.
In our paper board business, planned major maintenance outages are expected to reduce our earnings for 2021 compared to 2020 by $27 million.
Our guidance for 2022 planned major maintenance outages is on slide 20.
We expect to have additional major maintenance outages in 2023.
And we'll provide an update when we refine our estimates.
Our current view is that our tissue volume decline year-over-year will be above 20%, which is not adjusted for the impact of our exit from the away-from-home business.
In total, from 2020 to 2021, input cost inflation, including pulp, packaging, energy, and chemicals, as well as freight is expected to be $80 million to $85 million relative to our previous estimate of $60 million to $70 million.
Increasing energy, chemicals and fiber prices, drove our inflation expectations higher.
While pulp pricing has started to decrease, we do not expect for that to have a material impact on our financials until early next year.
The Neenah mill recently generated negative adjusted EBITDA by closing the site, we will avoid these losses and lower our overall cost structure by producing our retail volume at other lower cost sites.
These actions are helping us to fully realize the benefits of the Shelby North Carolina mill investment.
In total, the benefit from the Neenah closure is expected to exceed $10 million annually.
For the full year 2021, we are also anticipating the following.
Interest expense between $36 million and $38 million; depreciation and amortization between $104 million and $107 million; capital expenditures of approximately $42 million and $47 million, which is lower than our prior expectations; and historical average of around $60 million, excluding extraordinary projects, and our effective tax rate is expected to be 26% to 27%.
It has certainly been an interesting with robust SBS market conditions, significant inflationary headwinds and volatility and tissue demand.
As we mentioned previously, we believe that supply and demand drive near to medium term pricing and margins.
Our paperboard business is benefiting from these dynamics, while tissue remains challenged.
I'm proud of how our people have managed these challenges and opportunities.
We're committed to a strong finish in 2021 in positioning Clearwater Paper for future success.
For the last couple of quarters, I spoke about performance improvement efforts, focused on our core operations in the medium to long term.
These efforts are well underway and are aimed at offsetting inflationary and competitive pressures that we face in our industry.
It is important for us to invest in these efforts to maintain and grow our cash flows in the long run.
We're encouraged by the work to-date as we start moving from planning to execution, and believe that we are well positioned to combat margin compression in the next several years.
Let me remind you, why I think these businesses are well positioned in the long run.
For our paperboard division, we believe that the key strengths of this business are the following.
First, we operate well-invested assets with a geographic footprint, enabling us to efficiently service our customers.
We have a diverse customer base, which serves end markets that have largely stable demand.
Second, not being vertically integrated enables us to focus on independent customers with unparalleled service and quality commitment.
Third, we believe through product and brand development, the business is well positioned to take advantage of trends toward more sustainable packaging and food service products.
Lastly, our paperboard business has demonstrated an ability to generate good margins and solid cash flows.
Our Consumer Products division is a leader within the growing private branded tissue market.
From our vantage point, we believe the key strengths of this business are the following.
First, we have a national footprint with an ability to supply a wide range of product categories and quality tiers, which is an attractive sales proposition to our customers.
Our expertise in manufacturing, supply chain and transportation is a key differentiator.
Second, there are long-term trends away from branded products to private brand.
Private brand tissue share in the US rose to over 30% recently, up from 18% in 2011.
While these trends are impressive, we're still a long way from where many European countries are in which private brands represent over half of total tissue share.
Lastly, tissue is an economically resilient and an essential need-based product.
Historically, demand has not been negatively impacted by economic uncertainty.
We are optimistic that this business will generate meaningful cash flows over the long run.
We're committed to improving our business to be successful both in the near and long-term, and I firmly believe that we will come out of 2021, a better and stronger operation than where we started.
In addition, in addition to appropriately sustaining our asset base, our capital allocation plan is focused on paying down debt and improving our cost structure and operating performance.
As Mike mentioned earlier, with this plan, we will achieve our near-term target leverage ratio of 2.5x by 2023.
Our long-term capital allocation prioritizes maintaining a strong and flexible balance sheet with a focus on shareholder value.
We will share additional perspectives on our long-term capital allocation prioritization when we reach our near term leverage ratio target.
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compname posts q3 earnings per share of $0.11.
q3 earnings per share $0.11.
q3 adjusted non-gaap earnings per share $0.55.
q3 revenue $450 million.
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We hope you and your families are continuing to stay safe and well.
Now a few reminders before we go into the results.
These statements are based on management's current expectations, but may differ from actual results or outcomes.
In addition, we may refer to certain non-GAAP financial measures.
I'll start by covering our top line commentary, with highlights from each of our segments.
Kevin will then address our total company results as well as our FY '21 outlook.
Finally, Linda will offer her perspective, and we'll close with Q&A.
For the total company, Q2 sales increased 27%, with growth in every reportable segment.
It reflects about one point of net benefit from the July acquisition that gives us a majority share in our Saudi Arabia joint venture and unfavorable foreign currency exchange rates.
On an organic basis, Q2 sales grew 26%.
I will now go through our results by segment.
In our Health and Wellness segment, Q2 sales were up 42%, reflecting double digits increases in two of three businesses.
Our Cleaning business had double-digit sales growth behind strong ongoing demand across our portfolio.
Consumption remains high and, importantly, we're continuing to see increases in household penetration and repeat rates among existing and new users, driven by new routines developed from the prolonged pandemic as well as strategic brand investments.
While we expect tough comparisons as we lap these very high growth rates, we'll continue to work to retain the larger base of loyal consumers we've built for our cleaning and disinfecting products even after a critical mass of the population has been vaccinated.
We're continuing to make progress on our supply expansion, including a new line of wipes plant coming online this quarter.
We're also continuing to identify new sources of supply for other products experiencing constraints, including our disinfecting spray products.
As we're able to better meet consumer demand for our base products, we're looking forward to bringing back our Clorox compostable wipes, along with a stream of exciting innovation in the coming months.
Our Professional Products business had another quarter of double-digit sales growth behind continued high demand for our cleaning and disinfecting products.
It's worth noting, though, that while demand from businesses such as healthcare facilities has remained high, we've seen softer demand from businesses negatively impacted by ongoing mobility restrictions, like commercial cleaning and foodservice institutions.
That's why we're leaning into other out-of-home spaces through strategic alliances, and are encouraged by our progress.
While not yet a meaningful contributor in Q2, our out-of-home partnerships are expanding.
We're excited to announce a new multi-year deal with the NBA, an existing partner.
Lastly, within this segment, our sales in Vitamins, Minerals and Supplements business decreased in Q2.
This is a business where results have not been consistent, and we clearly have more work to do.
As you remember, we relaunched RenewLife last fall.
While we've seen improvements in all outlet consumption, it is not yet delivering the consistent results we want.
With more than half American consumers saying they intend to continue taking vitamins and supplements, we continue to believe in the attractiveness of this category.
Now turning to Household segment.
Quarterly sales were up 20%, with growth in all three businesses for a third consecutive quarter.
Grilling sales were up double digits, driven by continued strong consumption, which reflects the dramatic rise in in-home meal occasion as people continue to spend more time at home.
Behind our strategic collaboration with retailers, we've been able to grow household penetration for a third consecutive quarter, including among millennials and low-income consumers.
As we begin planning for the next growing season, we're building on our innovation through expanded distribution of our new Kingsford pellets and bringing new flavors to our Kingsford product lineup.
With consumer spending more on their backyard and growth, we feel optimistic about the future of this business.
Cat Litter sales were up by double digits in Q2, supported by innovation and continued strong performance online.
Our Fresh Step with Gain Original Scented Litter with the power of Febreze as well as our Fresh Step Clean Paws litter continued to perform very well, and we're supporting them through a new advertising campaign.
A record number of people have become pet parents since the onset of the pandemic in 2020, making this yet another example of how our diverse portfolio is particularly suited to the times.
Glad sales increased in Q2 behind strong demands across our portfolio of trash bags, wraps and food bags as people continue to spend more time at home.
Our latest innovation, Glad ForceFlex with Clorox trash bags, launched in September and is building distribution quickly, earning positive reviews.
In our Lifestyle segment, Q2 sales were up 9%, with double-digit growth in two of three businesses.
Brita sales were up by double digits for a fourth consecutive quarter behind continued strong shipments of pitchers as well as filters.
Just as with wipes and sprays, we're continuing to work through supply chain constraints in our Brita business, which has been impacting our shares.
We feel good about the long-term prospects of this business, especially since once people buy a Brita pitcher, they tend to stay in our franchise with continued purchases of filters.
Importantly, as household penetration for Brita keeps growing, we're building brand loyalty among these consumers.
The Food business had double-digit sales increase for a third straight quarter behind ongoing strong consumption of our Hidden Valley Ranch products, particularly dry seasonings and bottled dressings.
With more and more people eating at home during the pandemic, household penetration has grown to an all-time high, including above-average growth among millennials.
We're building on this momentum with a stream of innovation, including Hidden Valley Secret Sauces and, most recently, Hidden Valley plant-based ranch dressing, which is being supported by strong advertising investments.
Burt's Bees sales decreased by double digits as the business continued to be impacted by mobility restrictions as well as changes to consumer shopping and usage habits as a result of the pandemic.
This quarter, unseasonably warm weather also impacted lip balm sales.
Despite these challenges, we're making progress in the fast-growing online channel, where the brand had double-digit growth in Q2, and we remain confident in the long-term trajectory of this business.
Q2 sales grew 23%, driven by double-digit shipment growth in all major regions.
The growth reflects about nine points of benefit from the Saudi acquisition and about four points of unfavorable foreign currency headwinds.
Organic sales grew 18%.
The recent investment we made to create a dedicated international supply chain for Clorox disinfecting wipes is starting to pay off, giving us the ability to not only meet ongoing elevated demand in existing markets, but also to expand to new countries.
This is a strategic growth platform for the company, and we're supporting it through additional advertising investments.
We hope you and your families are well.
Our sales growth for the second quarter was broad-based, resulting in double-digit growth in each reporting segment for the first half of our fiscal year.
Additionally, this led to profitable growth for the first half, which enables us to capitalize on our momentum and continue investing behind our global portfolio to strengthen our competitive advantage.
Turning to our second quarter results.
Second quarter sales were up 27%, driven by 23 points of organic volume growth, three points of favorable price/mix and one point of net benefit from acquiring majority control of our Saudi joint venture, partially offset by FX headwinds.
On an organic basis, sales grew 26%.
Gross margin for the quarter increased 130 basis points to 45.4% compared to 44.1% in the year ago quarter.
Second quarter gross margin included the benefit of strong volume growth as well as 160 basis points of cost savings and 140 basis points of favorable price/mix.
These factors were partially offset by 420 basis points of higher manufacturing and logistics costs, which, similar to last quarter, included temporary COVID-19 spending.
Second quarter gross margin results also reflect about 50 basis points of negative impact from higher commodity costs, primarily from resin.
Selling and administrative expenses as a percentage of sales came in at 14.6% compared to 14.5% in the year ago quarter.
Advertising and sales promotion investment levels as a percentage of sales came in at about 10%, where spending for our U.S. retail business coming in at about 11% of sales.
This reflects higher investments across our portfolio, strengthening our value proposition to support higher levels of household penetration and lasting brand loyalty among new and existing consumers.
Our second quarter effective tax rate was 21%, which was equal to the year ago quarter.
Net of these factors, we delivered diluted net earnings per share of $2.03 versus $1.46 in the year ago quarter, an increase of 39%.
Turning to our updated fiscal year outlook.
We now anticipate fiscal year sales to grow between 10% to 13%, reflecting the strength of our first half results and higher expectations for the back half.
With our overall demand for our products remaining quite strong, we now expect back half sales to be about flat, on top of 19% growth in the year ago period.
We also anticipate about one point of contribution from our Saudi joint venture, offset by one point of foreign exchange headwinds.
On an organic sales basis, our outlook assumes 10% to 13% growth.
We now expect fiscal year gross margin to be down slightly, reflecting higher commodity and manufacturing and logistics costs as well as temporary costs related to COVID-19.
These factors are expected to be partially offset by higher sales.
As a reminder, we expect gross margin contraction over the balance of the fiscal year, primarily from two factors: first, we are lapping very strong operating leverage from robust shipment growth during the initial phase of the pandemic; and second, we're facing commodity headwinds this year versus last year's commodity tailwinds.
As a reminder, our gross margin expanded 250 basis points in the back half of fiscal year '20.
We continue to expect fiscal year selling and administrative expenses to be about 14% of sales, reflecting ongoing aggressive investments and long-term profitable growth initiatives and incentive compensation costs, consistent with our pay-for-performance philosophy.
Additionally, we continue to anticipate fiscal year advertising spending to be about 11% of sales.
We spent about 10% in the front half of the year and continue to anticipate about 12% in the back half in support of our robust innovation program.
We continue to expect our fiscal year tax rate to be between 21% to 22%.
Net of these factors, we now expect fiscal year '21 diluted earnings per share to increase between $8.05 and $8.25 or 9% to 12% growth, reflecting strong top line performance, partially offset by a rising cost environment.
We now anticipate fiscal year diluted earnings per share outlook to include a contribution of $0.45 to $0.50 from our increased stake in our Saudi Arabia joint venture, primarily driven by a onetime noncash gain.
I'm pleased we've raised our fiscal year '21 outlook.
Of course, it's important to note, we continue to operate in a highly dynamic environment and are monitoring headwinds that could result in impacts moving forward.
In closing, I'm also pleased with our broad-based strong results in the first half, which enables us to continue investing in our brands, capabilities and new growth opportunities, all in support of our ambition to accelerate long-term profitable growth for our shareholders.
I hope you and your families are well.
It's great to be here today showing Clorox's results for the first half of our fiscal year.
My messages this quarter largely reinforce what we discussed in Q1, with the most important point being that our global portfolio of leading brands continues to play a critical role in people's everyday lives.
My first message is that our first half results are rooted in purpose-driven growth.
Our purpose as a company is to champion people to be well and thrive every single day.
And our portfolio of leading brands is the bedrock of our ability to deliver on that promise.
Our first half results reinforce the important role our brands play in addressing people's everyday needs.
We continue to see broad-based strength in our portfolio, with double-digit sales growth for most of our businesses.
Clorox disinfecting products continue to be in high demand among consumers, businesses and healthcare settings.
And as people spend more time at home, we're continuing to see strong performance in other parts of our portfolio.
Kingsford is a great example.
As Lisah mentioned, our Grilling business delivered double-digit sales growth in the quarter.
And with a recharge strategy emphasizing innovation, I'm optimistic about the long-term prospects of this business.
They understand that, more than ever, people and communities need us.
I'm so grateful for their passion and commitment.
My second message is that Clorox will stay in the driver seat, continuing our posture of 100% offense to make the most of the opportunities in front of us while navigating an ongoing dynamic environment.
There's no question, Clorox has built significant momentum over the last year, and we have every intention of extending that longer term.
Our brand portfolio is especially relevant for this environment and for the consumer trends I mentioned last quarter, which we expect to persist beyond the pandemic, prioritizing hygiene and health and wellness, caring for pets and accelerating digital behaviors related to practically every aspect of their lives.
More than ever, as home is where the heart is, it's also where consumers are directing their investments with spending across many categories to support quality of in-home experiences.
This certainly bodes well for our portfolio.
We continue to see strong levels of household penetration.
Importantly, what we mentioned last quarter about repeat rates across our portfolio is playing out.
We're accelerating purchase frequency.
And repeat users are the source of most of our sales growth across our portfolio.
In addition, our strategic investments are creating a virtuous cycle around engaging and retaining new and existing users, resulting in a consumer retention rate of nearly 90%.
As I mentioned, 100% offense will help us extend this momentum, which, as a reminder, includes: investing more across our portfolio to retain the millions of people buying our brands; expanding our public health support to more out-of-home spaces; increasing capital spending for immediate and future production capacity, including wipes expansion in international; and partnering with our retailers to grow our categories.
Given the dynamic environment we continue to face, 100% offense also means actively planning for challenges and disruptions in the near and long term, including an inflationary cost environment, elevated competition in light of category tailwinds and accelerating advancements in digital technology that we expect to impact all areas of our business.
What's important is we'll continue to make strategic choices that position us to achieve our ambition to accelerate long-term profitable growth.
And finally, my third message is this.
As we continue to address immediate priorities related to unprecedented demand, we're also accelerating our progress against our strategy to deliver long-term shareholder value.
Our IGNITE Strategy continues to put people at the center of everything we do and helps us make the most of our strategic advantage in the near and long term.
Addressing unprecedented consumer demand for much of our portfolio continues to be an immediate priority.
We continue to make progress on a number of businesses.
We're bringing in more third-party supply sources and launching our new wipes line in our Atlanta facility in the third quarter.
Importantly, simplification is our mantra, and we're seeing the benefit of focusing on fewer SKUs, which we expect to continue beyond the pandemic.
As I mentioned earlier, we're growing Clorox Disinfecting Wipes international, supported by a dedicated supply chain.
Our expansion plans are going very well, and we expect to double the number of countries where Clorox wipes are sold.
Another immediate priority is to continue supporting people's safety when they're outside their homes through strategic alliances to support public health.
We're expanding our programs with Uber Technologies and Enterprise Holdings.
We recently established a multi-year deal with the NBA and look forward to pursuing similar opportunities with other organizations.
And as the pandemic continues to take a toll in the economy, we know that far too many people feel financial pressure from unemployment and less discretionary spending.
We're mindful of the role we can play to support those who are particularly value-sensitive, and we'll continue to deliver superior value through meaningful innovation.
Importantly, we're also making progress in laying the foundation for long-term growth.
We will continue to invest strongly in our global portfolio of leading brands, particularly behind robust innovation that differentiates our products and deliver superior value.
We will continue to reimagine how we work to ensure a strong culture, with a highly engaged team that works simpler and faster on strategic priorities.
I'm proud of how we've been operating during the pandemic, including accelerating our speed to market.
And finally, as we've said before, we view ESG as a contributor to competitive advantage, which is why it's embedded in our business.
Achievements this quarter include: being included in the 2021 Bloomberg Gender-Equality Index; achieving 100% renewable electricity in the U.S. and Canada four years early; signing on to the Energy Buyer Federal Clean Energy Policy statement, which calls for a 100% clean energy power sector; and donating $1 million to Cleveland Clinic to establish the Clorox public health research grant in support of science-based public health research.
We are grateful to play a role in supporting people and communities as we continue to navigate the global pandemic.
It only strengthens our resolve in pursuing purpose-driven growth, ensuring a strategic link between our impact on the world and long-term value creation for our shareholders.
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compname posts q2 earnings per share $2.03.
q2 earnings per share $2.03.
fiscal year 2021 sales are now expected to grow between 10% and 13%.
now anticipates fiscal year 2021 diluted earnings per share to increase between 9% and 12%, or $8.05 to $8.25.
fy 2021 diluted earnings per share outlook now estimates contribution of 45 to 50 cents from co's increased stake in its saudi joint venture.
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This is John Faucher, Chief Investor Relations Officer.
Actual results could differ materially from these statements.
I will provide commentary on our Q1 performance as well as our latest thoughts on 2021 guidance before turning it over to Noel to discuss our 2021 priorities.
We will then open it up for Q&A.
As usual, we request that you limit yourselves to one question so that as many people as possible get to ask a question.
We started 2021 in positive fashion with strong organic sales growth despite a very difficult comparison, which included some consumer pantry loading in March of last year.
Our net sales grew 6% in the quarter, organic sales growth of 5% was driven by 0.5% organic volume growth and a 4.5% increase in pricing.
Foreign exchange was a 1% tailwind in the quarter.
While the tough comparisons, particularly impacted our trends in developed markets, which were flat on an organic sales basis in the quarter, we delivered double-digit organic sales growth in emerging markets with volume up 5.5% and pricing up 6%.
We also delivered organic sales growth in three of our four categories; Oral Care, Home Care and Pet Nutrition, while Personal Care organic sales declined due to difficult comparison.
We believe our strategy to deliver more impactful premium innovation, which Noel and Pat Verduin talked about at CAGNY, is bearing fruit, and we will continue to focus in this area to drive future growth.
Our efforts on premiumization and pricing along with our focus on productivity, like our funding-the-growth initiatives, drove improvement year-over-year in our gross margin despite a worsening raw materials environment.
This gross margin expansion was a key factor in allowing us to deliver base business earnings-per-share growth in line with our full year guidance despite higher logistics costs, incremental advertising spending and investment to build capabilities.
In the first quarter, our gross profit margin was 60.7% on both a GAAP basis where we were up 50 basis points year-over-year, and a base business basis where we were up 40 basis points.
For the first quarter, pricing was 170 basis points favorable to gross margin, while raw materials were 310 basis point headwind.
This is a large impact for the first quarter and it was driven by increases in the cost of raw materials like resins, fats and oils, agriculture-related costs and the transactional impact from foreign exchange.
Productivity was a 180 basis point benefit.
Our SG&A was up 90 basis points as a percent of sales for the first quarter on both a GAAP and base business basis.
This was primarily driven by a 50 basis point increase in advertising to sales as we drove strong activation on brand building, innovation and e-commerce.
Our SG&A ratio was also impacted by increased logistics costs, primarily in the U.S. and investments behind growth and innovation.
Excluding advertising and logistics, our SG&A ratio declined year-over-year.
For the first quarter, on a GAAP basis, our operating profit was up 5.5% year-over-year, while it was up 5% on a base business basis.
Our earnings per share was down 4% on a GAAP basis and up 7% on a base business basis.
Our free cash flow was down year-over-year in the quarter against a very difficult comparison.
The decline was primarily driven by the negative impact of accounts payable and other liability, which was mostly due to changes in the timing of payables and income tax payments.
A few comments on our divisional performance.
Our volume declines in the quarter were primarily due to a combination of category deceleration in the face of difficult comparisons as we cycled last year's COVID pantry loading, logistics issues related to a warehouse transition on our U.S. business that impacted our shelf availability and our market shares and the winter storms in February.
Though logistics issues lessened over the last month of the quarter, service levels improved, and we expect service levels to return to normal by the end of the second quarter.
Pricing grew mid-single-digits in the quarter as our efforts in revenue growth management for pricing growth across all our categories.
The combination of higher raw materials costs, higher underlying logistics costs and costs related to remediating the company's specific logistics issues, pressured margins in the North America division.
Despite these headwinds, we continue to invest in advertising, particularly behind premium innovation like Colgate Renewal and the Colgate Optic White Overnight Teeth Whitening Pen and behind the continued strength of Colgate Optic White Renewal.
Latin America net sales were up 2% as 9.5% organic sales growth was mostly offset by the negative impact of foreign exchange.
We continue to deliver broad-based organic sales growth in Latin America with organic sales growth in all three categories and in every hub.
As we highlighted at CAGNY, our innovation in Latin America is driving growth in the premium segment of the toothpaste category.
In Brazil, Colgate Total is gaining share behind Colgate Total Anti-Tartar, and our Natural Extracts line is gaining share, particularly behind Charcoal.
Our toothpaste value share is flat year-to-date in Brazil and measured channels and is up year-over-year in e-commerce.
Europe net sales grew 6% in the quarter.
Organic sales were down 2%.
Volume declined 3.5% in the quarter as we lap strong shipments in the year ago period, which was driven by COVID-related demand and pantry loading.
Pricing was plus 1.5% as we took pricing across all categories to help offset raw material inflation.
We're launching equity campaigns across our core oral care equity; Colgate, meridol and elmex, and we're excited about the launch of Sanex Microbiome, which Pat talked about at CAGNY.
We delivered 16.5% net sales and 11% organic sales growth in Asia Pacific led by volume growth across our biggest markets; Greater China, India and the Philippines.
While China and India benefited from comparisons that included COVID-related shutdowns in 2020, our innovation continues to drive improved underlying performance, particularly in e-commerce.
Over the next several quarters, we will begin to rollout more premium innovation in brick and mortar in China like our Colgate Enzyme Whitening Toothpaste, leveraging the success we have had online in transforming our portfolio.
Africa/Eurasia net sales grew 8.5% as we delivered strong organic sales growth throughout the division.
Volume grew 5% in the quarter, while pricing was up 8%.
Foreign exchange was a 4.5% headwind.
This growth was led by our toothpaste and manual toothbrush businesses, although we also delivered organic sales growth in personal and home care.
Our business in Turkey delivered strong sales and market share performance, and launched significant premium innovation in naturals, charcoal and whitening.
Hill's started the year with another quarter of strong net sales and organic sales growth despite lapping significant growth in the year ago period.
Developed markets led the growth, particularly the U.S., Canada and Europe led by e-commerce.
Emerging markets grew organic sales greater than 20% in the quarter through a combination of volume and pricing growth.
We're very excited about our Hill's equity campaign addressing pet obesity.
This global campaign is leveraging digital, in-store, in-office and traditional media assets to drive growth in our weight control products across both our prescription and wellness businesses.
And now for guidance.
We still expect organic sales growth to be within our 3% to 5% long-term target range.
As we think about our current organic growth assumptions versus where we were three months ago, we're probably a little more cautious on developed markets.
As you've seen from the scanner data, our categories moved negative more quickly than we had anticipated, and we expect that to continue in the short-term.
Hopefully, this allows for some of the volatility to play itself out sooner in the year, and we will see trends stabilize more quickly.
Coming into this year, in categories where consumption rose last year due to COVID, we expected 2021 consumption levels to be below 2020, but above the levels we saw in 2019.
That is the case so far across our developed markets businesses, although year-to-date these categories are slightly weaker than expected.
Categories like toothpaste where usage did not spike in relation to COVID, should normalize more quickly as we move past some of the aggressive pantry loading in March and April of last year, and we're beginning to see that happen -- and the scanner data has returned to growth in the last several weeks.
We are encouraged by how we started the year in emerging markets.
We saw broad-based organic sales growth in our emerging markets across all the divisions and with a good balance of volume and pricing.
Comps will get more difficult as we go through the year, but we believe we have solid momentum.
Please note that given widespread COVID outbreaks in countries like Brazil, Mexico and India, we could still see an impact from government actions to stem the spread of COVID and other disruptions related to COVID, and this is not in our guidance.
Using current spot rates, we expect foreign exchange to be a low-single-digit benefit for the year, although slightly less favorable than when we gave guidance in January.
All in, we still expect net sales to be up 4% to 7%.
Our gross margin guidance remains unchanged as we expect our gross profit margin to be up year-over-year in 2021 on both the GAAP and base business basis.
As we mentioned on our 2020 year-end call, raw materials began the year moving higher and faster than we had expected.
This trajectory has continued through the first quarter, as you all know.
We are still laser focused on driving our gross margin higher, but the significant increase in costs across our materials base obviously requires additional pricing and productivity.
Advertising is still expected to be up on both a dollar and a percent of sales basis.
Logistics also continues to be a headwind, particularly in the U.S. where costs also have risen faster than anticipated.
We expect these costs to remain elevated in the near-term, but to moderate later in the year.
Our tax rate is expected to be between 23.5% and 24.5%.
We point out that our guidance does not account for any changes in U.S. corporate tax rates given the recent change in administration.
On a GAAP basis, we still expect earnings-per-share growth in the low-to-mid single-digit.
On a base business basis, we continue to expect earnings-per-share growth in the mid-to-high single-digit.
The adverse moves in foreign exchange and raw materials have moved to slightly lower in that range over the past few months, but it is still early in the year.
I'll keep my commentary brief since we've -- so we'll have plenty of time for the Q&A.
I think the results for the quarter really speak for themselves.
Obviously, we're really pleased with our performance in the first quarter.
Despite the significant volatility and headwinds, we delivered strong results around the world and up and down our P&L.
While we've made progress on our strategic areas we've been discussing, we still have a lot to do in the balance of the year.
Here are key priorities for the remainder of 2021.
Continue to drive broad-based growth.
Our priorities here are the same as we've discussed for the past several years.
We need to grow volume and pricing.
We need organic sales growth in every category and in every division in both emerging and developed markets.
In order to do this, we'll continue to ramp up our breakthrough and transformational premium innovation.
We delivered high-single-digit growth in toothpaste in the first quarter despite lapping solid growth in the year ago period, which help us drive high-single-digit growth in our oral care business.
We're driving growth through innovation like Colgate Renewal in the U.S., Colgate Enzyme Whitening Toothpaste in China and our Natural Extracts line in Colgate Total Anti-Tartar line in Latin America.
As Pat and I discussed at CAGNY, this is a marathon not a sprint, but we're making good progress which will continue as we shift our resources, continue to build new skills and even adapt how we motivate our teams.
Pricing is also an important element of growth.
And behind our revenue management efforts, we continue to drive strong pricing as we look to increase our price index versus the market as well as offsetting rising costs.
You're hearing about rising costs from every company this quarter, and we're seeing inflation on pretty much every line of the P&L, but especially raw materials, warehousing and logistics.
Naturally, our pricing plans are focused.
We just discussed, we're battling the cost inflation across the board.
We are also driving savings through funding the growth and other efficiency initiatives, which helped offset these headwinds, an effort Stan, our new CFO, is spearheading for us.
We do not expect these headwinds to abate any time soon, so we have to continue to invest in marketing and building capabilities for future growth, while delivering on our earnings guidance.
We know we need to be disciplined and efficient in this area.
The third is maintaining our focus on building out the key pillars of our long-term strategy, while simultaneously managing through all of the volatility.
That includes building our capabilities on innovation, e-commerce, digital and data and analytics, progressing on ESG including increasing our commitments on DE&I and advancing our 2025 sustainability targets, and then ultimately navigating to return to work for most of our office-based employees.
We are building a team and a culture at Colgate that is focused on adapting and changing to this volatile world.
We're embracing new strategies and new ways of working, and it's paying off.
We've had a good start to 2021 and we're looking to maintain our momentum through the rest of the year.
So with that, we'll go ahead and open up to questions.
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company reiterated its financial guidance for full year 2021.
delivered positive pricing in every division in quarter.
expects fy 2021 organic sales to be up within its long-term targeted range of 3% to 5.
colgate-palmolive - looking ahead, seeing volatility in consumer demand and currencies as well as increases in raw material prices and logistics costs.
expects fy 2021 net sales to be up 4% to 7% including a low-single-digit benefit from foreign exchange.
north america net sales decreased 0.5 percent in quarter.
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This is John Faucher, Chief Investor Relations Officer.
Actual results could differ materially from these statements.
I will provide commentary on our Q2 performance as well as our latest thoughts on 2021 guidance before turning it over to Noel to provide his thoughts on the current operating environment and how we will continue to deliver on our growth trajectory.
We will then open it up for Q&A.
As usual, we request that you limit yourself to one question, so that as many people as possible get to ask a question.
As we report results at the halfway point of 2021, we remain pleased, but not satisfied with our performance so far as we navigate through what can charitably be described as a complicated year.
For both the second quarter and on a year-to-date basis, we delivered growth in organic sales, net sales, operating profit and net income.
This is despite difficult comparisons as we lapped last years strength in categories like liquid hand soap and dish soap.
We are also dealing with the impact of COVID restrictions in several markets, economic and political uncertainty, strong competitive activity, and of course, significantly heightened raw material and logistics headwinds.
We expect that all of these factors will continue to impact our business through the second half of this year.
Because of that, we remain focused on delivering impactful innovation, leveraging our revenue growth management capabilities to deliver on pricing and driving productivity up and down the income statement.
All of these are crucial to deliver long-term sustainable growth that will help us as we look to deliver TSR at the high end of our peer group.
We delivered 5% organic sales growth in the second quarter, which marked our 10th consecutive quarter, delivering organic sales growth either in or above our targeted range of 3% to 5%.
As we have discussed before, the key to delivering against our long-term targets is delivering balanced growth, which we did once again in the quarter by delivering both volume and pricing growth.
We delivered growth in both developed markets with 3% organic sales growth and emerging markets, which delivered 7% organic sales growth.
We delivered organic sales growth in every division in North America.
Our largest category, Oral Care, delivered organic sales growth of nearly 10%, with organic sales growth across toothpaste, manual toothbrushes and electric toothbrushes, and organic sales growth in every division.
Innovation continues to be a vital contributor to our Oral Care business, as we benefit from new products across all of our divisions.
Products like Co by Colgate, Colgate Elixir toothpaste, and Colgate enzyme whitening toothpaste are all delivering consumer desired benefits and premiumizing our portfolio.
Pet Nutrition delivered organic sales growth of 15%.
Personal Care and Home Care declined on an organic sales basis year-over-year in the quarter as expected, but net sales remain above 2019 levels.
Net sales increased 9.5% in the quarter, which was our highest net sales increased in almost 10 years.
Foreign exchange was a 4.5% benefit to net sales as we lap the peak of last year's COVID-driven strength in the dollar.
After a strong gross margin performance in 2020 and in Q1, our gross margin declined in the second quarter due to the rapid acceleration of raw material costs across our business and the lapping of lower promotional levels in Q2 2020.
We took additional pricing in the second quarter, which will help offset raw material costs in the second half of the year and we will continue to layer in additional pricing where possible.
We expect raw material costs to remain elevated throughout 2021, but we do expect some sequential lessening of inflation as we get into the fourth quarter.
Our efforts on premiumization and pricing, along with our focus on productivity, like our funding the growth initiatives, will also help us as we look to improve our gross margin performance.
In the second quarter, our gross profit margin was 60%, which was down 80 basis points year-over-year on both a GAAP basis and a base business basis.
Year-to-date, our gross margin of 60.4%, down 10 basis points.
Again, that is on a GAAP and base business basis.
For the second quarter, pricing was 90 basis points favorable to gross margin, less than in the first quarter as we lapped lower promotional spending in the year-ago period when many of our markets reacted to COVID restrictions by pulling back on promotional activity.
Raw materials were at 370 basis point headwind as we continue to see significant pressure from resins, fats and oils and agriculture-related costs, and many other materials.
This includes a slightly favorable transactional impact from foreign exchange.
Productivity was a 200 basis point benefit.
Our SG&A was up 100 basis points as a percent of sales for the second quarter on both a GAAP and base business basis.
This was primarily driven by an increase in logistics costs and also by a 30 basis point increase in advertising to sales.
Excluding advertising and logistics, our SG&A ratio declined year-over-year as our net sales growth and savings programs drove leverage on our overheads.
For the second quarter on a GAAP basis, our operating profit was up 5.5% year-over-year, while it was up 2.5% on a base business basis.
Our earnings per share was up 12% on a GAAP basis and up 8% on a base business basis.
Our free cash flow was down year-over-year in the quarter as we continue to lap very strong working capital performance in the year-ago period.
As we discussed previously, our capital expenditures are also up year-over-year as we invest behind growth, productivity and our sustainability strategy.
A few comments on divisional performance.
North American net sales declined 4% in the second quarter with organic sales down 4.5% and a modest benefit from foreign exchange.
Volumes were down 8.
5% in the quarter, driven by Home Care and Personal Care, which saw strong growth in the year ago period, driven by COVID-related demand.
Pricing across Home Care and Personal Care was positive as we worked to offset higher raw material costs.
Oral Care organic sales grew mid-single digits, driven by innovation and pricing.
I mentioned Co by Colgate before, which is helping us further expand into the beauty and direct-to-consumer channels.
We are pleased with the initial performance of the Colgate Keep manual toothbrush.
It comes with an aluminum handle and by using our replaceable heads, consumers can use 80% less plastic compared to similarly sized Colgate toothbrushes.
We're also excited about our Tom's of Maine relaunch, which is bringing new graphics and advertising to a historic natural segment brand.
Our logistics issues that we discussed on the first quarter call continue to negatively impact our promotional timing, but service levels have improved and we expect our promotional cadence will normalize as we go through the third quarter.
Latin America net sales were up 12.5% with 8.5% organic sales growth and a 400 basis point benefit from foreign exchange.
All three categories delivered organic sales growth in the quarter with Oral Care organic sales growth in the high teens.
Brazil and Mexico both grew organic and net sales double digits in the quarter.
Our strong innovation performance was led by core innovation behind Colgate Total Reinforced Gums in Mexico, which apparently sounds much better in Spanish and Portuguese than English and several Charcoal variance in Brazil.
Volume was plus 2.5% in the quarter despite a sizable negative impact due to political unrest in Colombia, our third largest market in Latin America.
We believe this disruption, which negatively impacted our distribution network for some time is largely behind us, but political disruption will remain a risk, not just in Columbia, but in several markets.
Pricing was up 6% despite lapping lower promotional spending in Q2 2020 as well as some incremental pricing in the year-ago period as we look to offset foreign exchange.
Europe net sales grew 15% in the quarter.
Organic sales grew 5% driven by mid-teens growth in Oral Care, offset by declines in personal and home care as we lap COVID-related demand in the year-ago period.
Volume grew 7% in the quarter, offset by a 2% decline in pricing as we lap lower promotions in the year-ago period as store traffic declined in Q2 2020 due to COVID restrictions.
I mentioned Colgate Elixir toothpaste before and we're very excited about this truly differentiated product.
We designed it with more of a beauty esthetic, including skincare inspired ingredients, a unique clear recyclable bottle and liquid glide technology that allows the pace to leave the bottle leaving no messy tube or cap.
This product began rolling out across the division in Q2 with further launches this quarter.
We delivered 7.5% net sales and 1% organic sales growth in Asia Pacific this quarter, with organic growth in oral care partially offset by a decline in home care.
Volume growth of 3.5% was partially offset by negative pricing as we cycled lower promotional levels in the year-ago period given COVID-related lockdowns across the region, with the biggest impact coming on our South Pacific business.
We have additional pricing planned in the second half across the division to offset raw material cost inflation.
Volume growth was led by India, despite the impact of COVID related disruption in May.
And Thailand, driven by naturals innovation in the Colgate Vedshakti and Colgate Panjaved line as we lapped COVID-related disruptions in the year-ago period.
Our volume in China declined on growth on the Colgate business, which was more than offset by weakness in sales for our Hawley & Hazel joint venture, which is primarily related to inventory reductions in our distributor network.
After Eurasia continued its strong performance trend in the third quarter with net sales growth of 15.5%, as we delivered strong organic sales growth throughout the division once again.
Volume grew 9.5% in the quarter, while pricing was up 3.5%.
Foreign exchange was a 2.5% benefit in the quarter.
Oral Care delivered high teens organic sales growth and we are relaunching several of our naturals businesses with new packaging and flavors.
Hill's strong growth continued in the second quarter with 18% net sales growth and 15% organic sales growth.
Both developed and emerging markets delivered 10% volume growth as our increased investment around the globe is driving this highly differentiated brands.
In particular, we are seeing good results from our Hill's master brand campaign to end Pet obesity as well as our new campaign for Hill's Pet Essentials, our vet-distributed wellness product in Europe.
And now for guidance.
We still expect organic sales growth to be within our 3% to 5% long-term target range.
There is no meaningful change in our category expectations at this point.
The categories that benefited from COVID-related demand are behaving in line with our expectations with sales below 2020 levels, but ahead of 2019 levels.
Please note that given widespread COVID outbreaks in many of our markets, we could still see an impact from government actions to stem the spread of COVID and other disruptions related to COVID, and this is not in our guidance.
Using current spot rates, we expect foreign exchange to be a low-single digit benefit for the year, although slightly less favorable than when we gave guidance in April.
All in, we still expect net sales to be up 4% to 7%.
We have reduced our gross margin guidance for the year and we now expect gross margin to be down year-over-year for the full year on both the GAAP and base business basis given the additional cost inflation we have seen.
We expect the gross margin percentage to improve sequentially in the second half, which would leave us down modestly for the year.
As I mentioned above, we are taking many steps to mitigate the impact of these costs, including additional pricing, optimizing trade spending, accelerating FTG where available and many others.
Advertising is still expected to be up on both a dollar and a percent of sales basis.
Logistics will continue to be a headwind as costs also have risen faster than anticipated, particularly in the U.S.
We still expect these costs to moderate somewhat as we go through the balance of the year.
Our tax rate is now expected to be between 23% and 24% for the year on both a GAAP and base business basis.
On a GAAP basis, we still expect earnings-per-share growth in the low-to-mid single digits, but most likely toward the lower end of that range.
On a base business basis, we continue to expect earnings-per-share growth in the mid-to-high single digits.
Again, we would expect to land at the lower end of that range.
So the overriding message I want to lead with you today is that our strategy to reaccelerate profitable growth by focusing on our core adjacencies all over the world, new channels and markets is really working, as we like to say nothing moves in a straight line, but we now have 10 straight quarters of organic sales growth at or above our long-term target range.
Year-to-date, we at the high end of the range despite difficult comparisons and continued volatility in the business.
We're making good progress on our journey, but we still have more work to do.
And as I look back at my comments to you over the past 18 months that we've been dealing with the implications of COVID, there's one consistent theme that we keep coming back, managing through this crisis with an eye on the future.
This is still very appropriate theme, although obviously some of the elements have changed.
The prevalence of the vaccine in many developed markets gives us a sense of guarded optimism, but we've highlighted that many emerging markets which represent almost half of our revenues, the availability of the vaccine remains very low, case rates are high, and governments continue to put in restrictions to help stop the spread of the virus.
We remain hopeful that we will get to a post-COVID sooner rather than later, but we're not there yet.
We will continue to manage to the retail and supply chain disruptions, changes in consumer behavior and government actions to stem the spread of the virus, all while doing our best to protect the health and safety of our employees, which remains our number one priority.
But there are changing headwinds as well.
Last year, we were faced with adverse foreign exchange movements, heightened consumer and customer demand, supply chain volatility and uncertainty for our customers about changing business models and retail environments.
This year, we're faced with unprecedented cost increases for raw materials like resin, fats and oils and many others.
Logistic networks are taxed, whether it's the trucking and warehousing here in the U.S., or ocean freight coming from Asia to the rest of the world, and we're seeing some political disruption in markets like Colombia and Myanmar.
So 18 months into the COVID, many of the challenges are the same, some have changed, but our approach remains we will manage through the crisis with an eye on the future, and so far we feel we've done a pretty good job.
But we know the markets look forward at our potential, not backwards at our achievements.
We know that to deliver top-tier TSR, we need to balance organic sales growth both volume and pricing, all four of our categories and across all of our divisions.
We've talked to you a lot about our changes in strategy that will enable us to continue delivering this balanced growth.
First is our focus on breakthrough and transformational innovation.
Our emphasis is on faster growing channels and markets continues to pay off to growth in e-commerce, direct-to-consumer, discounters, club stores and pharmacies.
We're supporting these products with increased focus on our digital media and emerging data analytical capabilities.
But we have to deliver gross margin expansion to fund our brand investment, while we know -- while we now expect gross margin to be down modestly for 2021, it comes on the heels of strong gross margin expansion in 2020 and in the face of unprecedented increases in raw material prices.
We will continue to leverage our robust revenue growth management program and drive productivity so we can return to gross margin expansion.
We have made progress in our journey to improve our mix, but we have further upside potential on this given the benefits we provide to consumers and the fact that our brands under indexing pricing relative to the category across many geographies.
We're working to accelerate our productivity programs like funding the growth wherever possible to try and create additional offsets.
All this should help us in our drive to return to gross margin expansion.
And while the raw material inflation is obviously negatively impacting our gross margin performance this year, we're optimistic that this raw material inflation could drive an improvement in emerging market fundamentals.
Again, we need to first get through the difficulty surrounding COVID, but on the back of our continued rebound in emerging market organic sales growth, particularly in Latin America, we have some optimism that we could see some additional GDP growth and therefore higher category growth on the back end of this movement in commodities.
We have seen some of the emerging market currency stabilize for the first time and what seems like several years, and are optimistic this may be a first step.
And since our last call, we have released our 2025 sustainability strategy.
This comprehensive plan highlights the actions we're taking around climate, plastics, sourcing, diversity equity and inclusion, and all the other areas that are vital to the future, not only of our Company, but our communities and our planet.
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qtrly net sales increased 9.5%, organic sales increased 5.0%.
expect difficult cost environment to continue in back half of year.
despite significant raw material and logistics cost headwinds, we delivered another quarter of increased operating profit.
still expects 2021 net sales to be up 4% to 7% including a low-single-digit benefit from foreign exchange.
colgate-palmolive - on gaap basis, now expects increased advertising investment & earnings per share growth at lower end of its low to mid-single-digit range in 2021.
colgate-palmolive - on non-gaap basis, now expects increased advertising investment & earnings per share growth at lower end of its mid to high-single-digit range in 2021.
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This is John Faucher, Chief Investor Relations Officer.
Actual results could differ materially from these statements.
I will provide commentary on our Q3 performance, as well as our latest thoughts on 2021 guidance before turning it over to Noel to provide his thoughts on how we will continue to deliver on our growth trajectory.
We will then open it up for Q&A.
As usual, we request that you limit yourself to one question, so that as many people as possible get to ask a question.
Our focus on innovation, premiumization, pricing and productivity allowed us to deliver solid Q3 and year-to-date results despite a very difficult operating environment.
We continue to deliver against our targets because we are executing consistently on the strategy Noel laid out at CAGNY back in 2019.
We are focused on delivering consistent, sustainable, profitable growth; both volume and pricing growth, growth in all of our categories, growth in all of our divisions, emerging and developed markets.
And this has enabled us to deliver 11 straight quarters with organic sales growth in line with or above our long-term target of 3% to 5%.
This is despite very difficult comparisons and a challenging operating environment.
The current operating environment is challenging in many different ways.
Consumer mobility is limited in many markets, particularly in Asia, due to government restrictions to stop the spread of COVID-19, which is having a negative impact on category growth.
These restrictions have also led to temporary closure of manufacturing facilities across many industries as you've heard in the news and from other companies.
We are not immune to these restrictions, although, given the essential nature of our categories, we produce products that people and their pets use on a daily basis to lead healthier lives.
We have been able to resume production throughout our network, although, sometimes at a lower-than-normal level.
This did have a slight impact on sales in the third quarter and we expect a modest impact in the fourth quarter as we ramp production back up.
We are fortunate to have a flexible and resilient global supply chain that has helped us to offset some of the effects of the supply chain challenges, albeit sometimes with additional logistics costs.
Speaking of logistics, the stress on global logistics networks is creating shortages of raw materials, lengthening shipment times, increasing costs and adding additional uncertainty.
All of this is on top of the significant increases in raw material costs and continued movement in foreign exchange.
These challenges will continue into next year but we will continue to meet them head on.
Our net sales grew 6.5% in the quarter, driven by 4.5% organic sales growth and a 2% benefit from foreign exchange.
Our organic sales growth in the third quarter was led by Oral Care, where we were up mid-single-digits, and Pet Nutrition, where we were up double-digits.
We delivered organic sales growth in Home Care, despite a difficult comparison, which puts our Home Care business at double-digit growth on a two-year stack.
As expected, organic sales in Personal Care declined mid-single-digits as we lapped the COVID-related growth in liquid hand soap in the year ago period but sales remain above 2019 levels.
We grew volume 1.5% in the quarter.
Pricing grew 3% in the quarter, up sequentially from Q2, despite a more difficult 4.5% comparison as we continued to layer in new pricing to try to offset accelerating raw materials costs.
Pricing was up in every category and every division.
Raw materials continued to increase in Q3, putting further pressure on our gross margins, despite additional pricing and productivity efforts.
Our gross margin was down 180 basis points in the quarter.
Pricing was a 110 basis point benefit to gross margin, while raw materials were a 510 basis point headwind, despite a slight benefit from transactional foreign exchange.
Productivity was favorable by 220 basis points.
On a GAAP and Base Business basis, our SG&A was up 50 basis points on a percent of sales, driven by significant increase in logistics costs as advertising was up on a dollar basis, but flat on a percent of sales basis.
Excluding logistics and advertising, our overheads were down slightly on a dollar basis and down nicely on a percent of sales basis.
We continue to increase our investments in capabilities like digital, e-commerce and data and analytics, but this was more than offset by sales leverage and tight expense controls.
For the third quarter, on a GAAP basis, our operating profit was down 5% year-over-year, while it was down 3% on a Base Business basis.
Our earnings per share was down 7% on a GAAP basis and up 3% on a Base Business basis.
A few comments on our divisional performance.
Net sales in North America grew 1% in the third quarter with organic sales growth of 0.5% and 50 basis points of favorable foreign exchange.
Volumes were flat in the quarter, despite a negative nearly 400 basis point impact from lower liquid hand soap volumes, while pricing was slightly favorable.
We made significant progress on our North American business in the quarter with solid Oral Care growth, driven by mid-single-digit growth in toothpaste, which led to improved toothpaste market share performance through the quarter.
Personal Care and Home Care were both down as we lapped COVID benefits in the year-ago period, although EltaMD and PCA Skin delivered strong growth in the quarter.
North America operating margins were negatively impacted by raw materials and higher logistics costs.
The impact of plant closures on our global supply chain required us to incur additional air freight charges to fulfill customer orders in the quarter.
We also incurred some additional manufacturing costs in the quarter that should help improve the long-term profitability of the division.
Latin America net sales were up 11% with 8% organic sales growth and a 300 basis point benefit from foreign exchange.
All three categories delivered organic sales growth in the quarter with Oral Care organic sales growth in the high-single-digits.
Volume was plus-2.5% in the quarter, while pricing was up 5.5%.
Brazil and Mexico led the growth in the quarter, while Colombia delivered double-digit growth following last quarter's political unrest.
The Naturals segment continues to be a key driver of growth for us across Latin America, particularly Colgate Natural Extracts Charcoal and we recently launched Colgate Zero Toothpaste in Brazil.
Our strong Latin America pricing growth highlights the success of our revenue growth management program with a combination of list price increases, premium innovation and trade promo adjustments.
Europe net sales grew 1% in the quarter with organic sales minus-1% and foreign exchange adding 2%.
Volume was down 1% and pricing was flat.
Oral Care organic sales grew high-single-digits, while Personal Care organic sales were down sharply, driven by difficult liquid hand soap comparisons due to COVID-related consumption in the year-ago period and a decline in Filorga duty-free sales.
Colgate Elixir Toothpaste continued to drive growth in the quarter along with strong contributions from elmex and meridol.
Asia-Pacific net sales grew 1% and organic sales declined 0.5% in the quarter, with volume down slightly and pricing and foreign exchange, both slightly positive.
Oral Care saw low-single-digit organic sales growth in the quarter, while Personal Care and Home Care were down due to difficult COVID comparisons.
We did see government-imposed mobility restrictions negatively impacting category volumes in several markets, including many in Southeast Asia.
India and the Colgate China business both delivered strong volume growth behind robust innovation in the ayurvedic segment in India, and in e-commerce in China.
Our Hawley & Hazel JV saw significantly improved performance in Q3 versus Q2 with trends also improving sequentially during the quarter.
Africa/Eurasia net sales grew 1% in the quarter with organic -- with an organic sales decline of 1% lapping double-digit organic growth in the year-ago period, more than offset by a 2% positive impact from foreign exchange.
Volumes were minus-4.5% while pricing was plus-3.5%.
The organic sales growth decline in the quarter was driven by Personal Care as we lapped double-digit growth in the year-ago period due to COVID-related demand and pricing.
Oral Care organic sales in the quarter were flat as disruptions in the global supply chain had a negative impact on product availability.
Hill's strong growth continued in the third quarter with 20% net sales growth and 19% organic sales growth with strong growth in both emerging and developed markets.
Organic sales growth was driven by double-digit volume growth and high-single-digit pricing through list price increases and our premiumization strategies.
And now for guidance.
We still expect organic sales growth for the year to be within our 3% to 5% long-term target range.
As I mentioned previously, we have seen an impact from government actions to stem the spread of COVID-19, including reduced consumer mobility and supply chain interruptions.
We are managing through these issues, but we would expect modest headwinds from this to continue in the fourth quarter.
Using current spot rates, we expect foreign exchange to be a low-single-digit benefit for the year, although slightly less favorable than when we gave guidance in July.
Please note that at current spot rates, foreign exchange would have a negative impact on Q4.
All in, we still expect net sales to be up 4% to 7%.
Given the continued pressures from raw materials, we are projecting a greater decline in gross margin than when we last gave guidance in July.
Fourth quarter gross margin is expected to be roughly in line with the third quarter, although the raw material situation remains very difficult.
We continue to take additional steps to mitigate the impact of these cost headwinds, including additional pricing, optimizing trade spending, accelerating FTG where available, and many others.
We are focused on recouping the gross margin we have lost due to cost inflation over time and are planning to take the actions necessary to do so.
Advertising is still expected to be up on a dollar basis, but flat on a percent of sales basis.
Given the issues surrounding logistics networks on a global basis, our logistics costs will continue to be a headwind, particularly in the U.S. and Africa/Eurasia.
Our tax rate is now expected to be between 22% and 23% for the year on both a GAAP and Base Business basis.
On a GAAP basis, we still expect earnings-per-share growth in the low-to-mid single-digits and, as we said on the second quarter call, toward the lower end of that range.
On a Base Business basis, we continue to expect earnings-per-share growth in the mid-to-high single-digits.
Again, we would expect to land at the lower end of that range.
So what I take away from our performance, I guess, both in the third quarter and on a year-to-date basis is that we continue to make good progress on our strategic and operational journey despite the significant volatility we are encountering across our entire business.
At the heart of this is our strategy to deliver broad-based sustainable profitable growth; every division, every category, both volume and pricing.
That's our aspiration and over the past few years, we have changed our mindset about how we drive growth.
We're more proactive in attacking the opportunities for growth, think core, premium adjacencies, faster alternative channels and markets.
And of course, we've talked a lot about building capabilities, think digital, data, e-commerce, innovation.
All of these are helping us mine these important areas of growth.
While lapping our most difficult comparisons in over a decade, we delivered organic sales growth at the high end of our long-term target range of 3% to 5%.
And on a two-year basis, both pricing and volume growth increased sequentially in the quarter.
Importantly, this growth has been driven by our two most important categories: Oral Care and Pet Nutrition.
Oral Care organic sales were up mid-single-digits in Q3 against the mid-single-digit comparison and are up high-single-digits year-to-date.
We're driving this growth through more impactful innovation, share growth in faster growth channels like e-commerce and pharmacies, and higher more efficient marketing spending.
Our premiumization strategy is paying off with our focus on breakthrough and transformational innovation, changing how we interact with the people who use our products.
A great example of this is how we've changed our approach to whitening.
In the U.S,, you're familiar with Optic White Renewal, which has done incredibly well.
Outside the U.S., the story needs to be more about just hydrogen peroxide levels.
In China, it's about enzyme-based whitening.
In other markets, we have whitening products targeted toward consumers who love tea or coffee or consumers who love wine or tobacco.
We're targeting a whitening opportunity much more broadly with new technologies, formulations and delivery systems, expanding our growth potential.
Pet Nutrition organic sales growth was up 19% in the quarter against an 11% comparison and is now up 14% year-to-date through quarter three.
This growth is driven by Hill's science-based equity messaging behind our core.
It's driven by meaningful premium innovation and the continued expertise of our digital and e-commerce teams.
The launch of Prescription Diet Derm Complete through [Phonetic] its breakthrough therapeutic nutrition for both food and environmental sensitivities has led to share gains in the category and is being rolled out internationally over the next few quarters.
Hill's goal of ending pet obesity, where a study show over 50% of pets are overweight, is the impetus for our Hill's master brand campaign.
This campaign has been rolled out globally and has driven growth in both our therapeutic and wellness anti-obesity products.
In this type of environment, we couldn't deliver the results without -- this year without the amazing work done by Colgate people every day.
Our customer development organization is reacting quickly to the changing cost environment so we can take pricing as part of the revenue growth management initiative.
Marketing and R&D are working together to accelerate the launch of premium innovation to drive mix and profitability.
And most importantly, our global supply chain team has delivered these results despite freight and logistics disruptions, plant closures, congested ports and supplier outages.
Importantly, all of the efforts we have put into building capabilities over the past few years is not just about driving growth, it's also about creating an organization that can respond more rapidly to all these challenges we face around the world.
For example, our focus on data and analytics is helping our revenue growth management program pinpoint the best opportunities for incremental pricing as costs continue to rise.
We're getting this pricing out in the market more quickly and the data that drives that process gives our people on the ground more confidence in their decisions.
Our investment in e-commerce and digital marketing continues to pay off.
In our six largest e-commerce markets for Oral Care, we finished the third quarter with year-to-date net sales already ahead of '22 net sales -- 2020 net sales, and toothpaste share growth in five of the six markets.
We've implemented new media buying strategy to drive efficiencies, both online and offline, and launched a 4-tier training program to enable 14,000 of our employees to help drive our digital strategy.
As I've said, the key through all of this is that we recognize that the strategy is working.
And while we address the pressing issues of raw materials, logistics and supply chain, we can't lose sight of our long-term areas of focus.
Our Innovation calendar for 2022 will show an increase in the percentage of innovation that is breakthrough and transformational.
We've announced our new sustainability and social impact strategy this year, which includes 11 new targets and actions in areas like zero-waste, climate change, using less plastic, as well as Bright Smiles, Bright Futures and our diversity, equity and inclusion efforts.
And we will continue to build our people and capabilities through new ways of working that are truly changing how Colgate people do their jobs.
2021 has been very challenging year for us and many of these challenges will continue in 2022, but I'm confident of the changes that Colgate people put in place over the past several years, which will allow us to continue to deliver our goal of sustainable profitable growth.
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confirmed its financial guidance for full year 2021.
qtrly net sales increased 6.5%, organic sales increased 4.5%.
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The year is off to a good start.
In the first quarter, we generated earnings of $2.43 per share, a 59% increase over the fourth quarter, primarily driven by strong credit quality.
Our ROE grew to over 18% and our ROA was 1.68%.
I am pleased to report that we are hearing more optimism among our customers and colleagues across our markets.
Stimulus payments to individuals and enhanced unemployment benefits, along with PPP loans to small- and medium-sized businesses have provided much needed relief to those that are struggling.
Also, the Infrastructure Bill that is being considered is expected to spread spending over many years.
This fiscal stimulus and the ramp up in the vaccine distribution, in combination with ample liquidity and low borrowing costs, has the potential to spur substantial activity.
The economic metrics are improving quickly and the outlook for the back half of the year is for strong economic growth.
As the economy continues to reopen and pre-pandemic conditions return, many businesses are beginning to experience accelerating activity.
I remain very proud of the unwavering commitment of our team to serve our customers, communities and each other.
We've again stepped up our efforts to support those affected by the pandemic.
Last month, Comerica and the Comerica Charitable Foundation pledged approximately $16 million to support small businesses and communities impacted by COVID.
This support is in addition to the $11 million committed in 2020.
As you know, last year, we funded $3.9 billion in the first round of PPP loans.
Also, so far this year, through the hard work of colleagues across the Bank, we further assisted businesses by funding close to $1 billion in the second round of PPP.
In addition, in the first quarter, we processed over $600 million in PPP loan repayments, mainly through forgiveness.
Turning to our first quarter financial performance on Slide 4.
Compared to the fourth quarter, average loans decreased with seasonally lower home purchase volumes impacting our Mortgage Banker business.
Also, total line utilization across nearly all businesses have remained low.
However, our loan pipeline has continued to grow.
Average deposits increased over $1 billion to another all-time high as customers received additional stimulus payments.
Net interest income was impacted by $17 million in lease residual adjustments in an expiring legacy portfolio.
Excluding this impact, pre-tax pre-provision net revenue increased 5% despite the shorter quarter and the decline in loan volume.
This increase in PPNR was due to continued robust fee generating activity in our expense discipline.
As far as credit, our conservative culture, diverse portfolio, as well as deep expertise has served us well.
Strong credit performance and an improvement in our economic forecast resulted in a negative provision of $182 million.
The credit reserve remains healthy at 1.59%.
Net charge-offs were only 3 basis points.
Through the cycles, our net charge-offs have typically been at or below our peer group average, including during the past year as we navigated the pandemic.
With more confidence in the economic recovery and an estimated CET1 ratio of 11.09%, we plan to restart share repurchases.
In the second quarter, we expect to make significant strides toward our 10% target, giving careful consideration to earnings generation, as well as capital needs to fund future loan growth.
Our ongoing goal is to provide an attractive return to our shareholders, which includes a dividend that currently has a yield of about 4%.
Turning to Slide 5, average loans decreased approximately $800 million.
As Curt mentioned, the biggest driver was Mortgage Banker, which declined from its record high in the fourth quarter due to lower purchase volumes.
Energy decreased as higher oil prices are resulting in improved cash flow and capital markets activity.
We had expected National Dealer loans would begin to rebound in the first quarter.
However, supply chain issues, most notably with computer chips have STIMI [Phonetic] production.
In addition, March auto sales were the second highest of all-time for that month, further depleting inventory.
Dealer loans were $1.5 billion below the first quarter of 2020.
We remain confident in the floor plan balances will eventually rebuild to historical levels.
Equity Fund Services was a bright spot, increasing over $200 million with strong fund formation.
Total period end loans reflected decreases of $900 million in Dealer and $700 million in Mortgage Banker.
Line utilization for the total portfolio declined to 47%.
We feel good about the pipeline, which now sits above pre-pandemic levels.
It increased to nearly every business line and loans in the last stage of the pipeline nearly doubled over the fourth quarter.
Ultimately, we would expect this to translate into loan growth.
As far as loan yields, there were $17 million in lease residual value adjustments, mostly on aircraft and an expiring legacy portfolio.
We have not done business in this segment for many years and no further adjustments are expected.
Excluding the 14 basis point impact from the residual adjustment, loan yields increased 3 basis points with the benefit of accelerated fees from PPP forgiveness.
Continued pricing actions, particularly adding rate floors when possible as loans renew, offset the decline in LIBOR.
Average deposits increased 2% or $1.1 billion to a new record as shown on Slide 6.
Consumer deposits increased nearly $1 billion, primarily due to seasonality and the additional stimulus received in January.
Customers continue to conserve and maintain excess cash balances.
With strong deposit growth, our loan-to-deposit ratio decreased to 69%.
The average cost of interest-bearing deposits reached an all-time low of 8 basis points, a decrease of 3 basis points from the fourth quarter and our total funding cost fell to only 9 basis points.
Slide 7 provides details on our securities portfolio.
Period end balances are up modestly as we recently began to gradually deploy some of our excess liquidity by opportunistically increasing the size of the portfolio.
Lower rates on the replacement of about $1 billion in payments received during the quarter resulted in the yield on the portfolio declining to 1.89%.
Yields on repayments averaged approximately 235 basis points, while recent reinvestments have been in the low-180s.
We expect to mostly offset the yield pressure on MBS in the near term with a modestly larger portfolio.
However, maturing treasuries will likely be a slight headwind in the back half of the year, depending on the mix of MBS and treasuries we would likely replace them with, as well as market conditions.
Turning to Slide 8, excluding the impact of the lease residual adjustment and two fewer days in the quarter, net interest income was roughly stable and the net interest margin would have increased 2 basis points.
As far as the details, interest income on loans decreased $28 million and reduced the net interest margin by 8 basis points.
This was primarily due to the $17 million of lease residual adjustments, which had a 9 basis point impact on the margin, as well as two fewer days in the quarter, which had a $7 million impact.
Lower loan balances had a $5 million impact and were partially offset by a $3 million increase in fees related to PPP loans.
Other portfolio dynamics had a $2 million unfavorable impact and included lower LIBOR, partially offset by pricing actions.
Lower securities yields, as I outlined in the previous slide, had a $2 million or 1 basis point negative impact.
Continued prudent management of deposit pricing added $3 million and 1 basis point to the margin and a reduction in wholesale funding added $1 million and 1 basis point.
Average balances of the Fed were relatively steady and remain extraordinarily high at $12.5 billion.
This continues to weigh heavily on the margin with the gross impact of approximately 41 basis points.
Credit quality was strong and metrics are moving in the right direction as shown on Slide 9.
Net charge-offs were only $3 million or 3 basis points.
Non-performing assets decreased $34 million and at 64 basis points of total loans, they are about only half of our 20-year average.
Inflows to non-accrual were also very low.
Criticized loans declined $366 million and comprised 5% of the total portfolio.
Positive migration in the portfolio, combined with growing confidence and improving economic forecast, resulted in a decrease in our allowance for credit losses.
Of note, both the social distancing-related segments, as well as the Energy portfolio have performed better-than-expected.
However, we continue to apply a more severe economic forecast to these areas.
Our total reserve ratio is very healthy at 1.59% or 1.72% excluding PPP loans and remains well above pre-pandemic levels.
Non-interest income increased $5 million as outlined in Slide 10, sustaining the positive trend we've seen for the past year.
Derivative income increased $11 million as volumes remain robust, particularly for energy hedges, combined with a $10 million benefit from a change in the credit valuation adjustment.
Note that we have made a change in reporting, we have combined foreign exchange and customer derivative income, which was previously included in other non-interest income into a combined derivative income line item.
Prior periods have been adjusted to reflect this change.
Warrants and investment banking fees moved higher and we had smaller increases in fiduciary and deposit service charges.
Partly offsetting this, commercial lending fees decreased $6 million with the seasonal decline in syndication activity.
Deferred comp asset returns were $3 million, a $6 million decrease from the fourth quarter and are offset in non-interest expenses.
Note, card fees remained elevated.
They were over 20% higher than a year ago due to government card and merchant activity spurred by the economic stimulus and changes in customer behavior related to the COVID environment.
All in all, another strong quarter for fee income.
Turning to expenses on Slide 11, which decreased $18 million or 4%.
Starting with salaries and benefits, which were up $11 million due to seasonal factors.
This increase was driven by annual stock compensation and payroll taxes resetting.
Providing a partial offset was a decrease in deferred comp, as well as a reduction due to two fewer days in the quarter and seasonally lower staff insurance costs.
All other expenses decreased $29 million.
As discussed last quarter, strong investment performance in 2020 has resulted in an $8 million reduction in pension costs, which is included in other non-interest expense.
In addition, effective January 1, we adopted a change in the accounting method for our pension plan.
Previous quarters have been adjusted, specifically fourth quarter pension expense was reduced by $8 million.
This change also decreased AOCI and increased retained earnings at year-end by $104 million, which resulted in a 16 basis point increase to our CET1 ratio.
Finally, we realized seasonal decreases in advertising and occupancy, lower operating losses and FDIC expense, as well as smaller decreases in other categories.
Our strong expense discipline is assisting us in navigating this low rate environment as we invest for the future.
Our CET1 ratio increased to an estimated 11.09% as shown on Slide 12.
As always, our priority is to use our capital to support our customers and drive growth while providing an attractive return to our shareholders.
In this regard, we have maintained a very competitive dividend yield.
As far as share repurchases, we have a long track record of actively managing our capital and returning excess capital to shareholders.
With more confidence in the path of the economic recovery, we plan to resume share repurchases in the second quarter.
We expect to make significant strides toward our CET1 target of 10%.
Slide 13 provides our outlook for the second quarter relative to the first quarter.
In addition, we have provided expected trends for the second half of the year relative to the second quarter outlook.
In the second quarter, excluding PPP loans, we expect loan volume to be stable.
We expect growth in several lines of business led by middle market as a result of increasing M&A, as well as working capital and capex needs.
However, this will be offset by continuing headwinds in Mortgage Banker, National Dealer and Energy.
In line with the MBA forecast, Mortgage Banker is expected to decline as refi volumes begin to cool with higher rates.
We expect National Dealer to continue to decrease as auto inventory levels are challenged by strong demand combined with supply issues.
Also, Energy loans are expected to remain on the current declining trend as higher oil prices are driving improved cash flow and capital markets activity.
As far as PPP loans, it is difficult to predict.
However, we believe loan forgiveness will pick up toward the end of the second quarter and the bulk should be repaid by year-end.
Excluding PPP loan activity, we believe loans should grow across nearly all business lines in the second half of the year.
This is based on our robust pipeline and expectations that the economy will continue to strengthen.
We expect average deposits to remain strong with the second quarter benefiting from the latest federal stimulus.
These record levels are expected to wane in the back half of the year as customers start to put cash to work.
As far as net interest income, the $17 million lease residual adjustment we took in the first quarter will not recur.
That aside, all other factors, including PPP are expected to offset each other in the second quarter.
For example, headwinds from lower reinvestment yields on securities should be offset by a modestly larger portfolio.
As we move into the second half of the year, we expect pressure on securities yields and swap maturities to be roughly offset by non-PPP loan growth.
In addition, lower PPP loan volume and accelerated fees are expected to be a headwind.
Of course, PPP activity is difficult to predict and may result in variability.
Credit quality is expected to remain strong.
Assuming the economy remains in the current path, we expect our allowance should move toward pre-pandemic levels.
We expect non-interest income in the second quarter to benefit from higher card fees driven by recent stimulus payments, as well as increased syndication fees following lower seasonal activity in the first quarter.
Also, we expect growth in fiduciary income reflecting annual tax-related activity and new business generation.
This growth is expected to be more than offset by a decline in derivatives and warrants income from elevated levels, as well as deferred comp, which is not assumed to repeat.
As we progress through the year, we believe customer-driven fee categories in general should grow with improving economic conditions.
However, card fees are expected to be a headwind as the benefit from growing merchant and corporate volumes could be more than offset by lower government card activity due to the absence of further individual stimulus payments.
We expect expenses to be stable in the second quarter.
Salary and benefit expenses are expected to decrease in the second quarter with lower stock comp, as well as lower payroll taxes, partly offset by annual merit and one additional day.
Offsetting this decrease, we expect a rise in outside processing tied to growth in card fees, as well as seasonally higher marketing and occupancy expenses.
As far as the second half of the year, by maintaining our focus on expenses, we expect to offset higher tech spend.
In addition, we expect increases in certain line items due to seasonality and revenue growth.
Finally, as I indicated on the previous slide, we plan to restart share repurchases in the second quarter.
As I mentioned at the beginning of the call, we are off to a good start and we expect the economy will continue to improve throughout this year.
We believe firming manufacturing conditions, increasing business and consumer confidence, as well as pent-up demand will support strong economic growth.
It is hard to believe that just over a year ago we drastically changed the ways in which we work and live.
We have demonstrated the resilience of our business model as we embraced our core values and rose to the occasion to support our customers, communities and each other.
Our success is anchored by our ability to provide our expertise and experience to build and solidify deep, enduring relationships, particularly during challenging times.
I'm extremely proud of the work our team has done to ensure we continue to deliver the same high-level of service.
We are focused on delivering a more diversified and balanced revenue base with an emphasis on fee generation, and our progress is demonstrated in our results as non-interest income has increased in each of the past four quarters.
Our robust card platform is a great example has helped position us for the recent and likely ongoing changes in customer behavior.
Also, our fiduciary business is growing with strong collaboration between Wealth Management, Commercial and Retail Bank divisions.
In February, we increased the breadth and scale of our Trust Alliance business through the acquisition of a small group with expertise in this area.
In addition, we are committed to maintaining our strong expense discipline.
Our technology investments are enhancing the customer and colleague experience, helping to attract and retain customers and improving colleague efficiency.
Finally, our disciplined credit culture and strong capital base continue to serve us well.
These key strengths provide the foundation to continue to deliver long-term shareholder value.
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compname reports q1 earnings per common share of $2.43.
qtrly earnings per common share $2.43.
qtrly provision for credit losses decreased $165 million to a benefit of $182 million versus q4 .
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Today we reported earnings of $211 million, an increase of 87% over the second quarter.
Our customers continue to act prudently, conserving cash and adjusting their operations, driving a reduction in loans and taking deposits to a new record.
Lower loan balances along with strong credit metrics and an improving yet uncertain economic path resulted in the allowance for credit losses remaining near 2% and a provision of $5 million.
As far as revenue, the impact from lower interest rates waned, card fees remained robust and other fee income categories began to recover.
Expenses are well controlled and included a $4 million increase in charitable contributions.
ROE returned to double-digits at nearly 11% and our book value per share grew to $53.78, the seventh consecutive quarterly increase.
We remain focused on continuing to enhance shareholder value.
Based on recent conversations I've had with employees and customers, sentiment appears to be modestly better, reflecting cautious optimism and a sense of hope for the future based on our country's overall economic resiliency.
We've begun to see some signs of improving conditions.
However, it is very difficult to predict the pace of the recovery.
This is reflected in our loan portfolio, where overall, we are starting to see some positive trends.
Balances begin to grow mid-quarter and increased modestly month-over-month in September.
Also, our pipeline has begun to rebuild, although it remains well below pre-COVID levels.
On a full quarter average basis, loans decreased $1.5 billion in the third quarter.
The largest contributor was a $910 million drop in average National Dealer loans in conjunction with significant decline in dealer inventory levels in the second quarter, which have yet to recover.
This is due to supply backlogs following the manufacturing shutdown combined with the rebound in sales activity.
We anticipate loans will rebound next year as auto inventory returns to normal levels.
Deposits continue to show strong broad-based growth with average balances increasing $4.5 billion, including $3.2 billion and non-interest-bearing deposits.
Government stimulus programs have provided tremendous liquidity.
In addition, as we've seen in other times of economic uncertainty, our relationship-based customers are maintaining a building cash in safety or their Comerica accounts.
The resulting increase in liquidity drove our total average assets to a record $84.3 billion.
As expected, net interest income declined $13 million as lower interest rates had a $15 million impact.
In this ultra-low rate environment, we continue to carefully manage loan and deposit pricing to attract and maintain customer relationships.
Comerica has a strong credit culture with conservative credit underwriting which has served us well in times of economic stress.
During the current period of unprecedented disruption, our portfolio has performed well, and we believe this will continue to be a differentiator for us in the industry.
Criticized loans remained stable and non-performing assets are well below historic norms.
Also, net charge-offs decreased only 26 basis points.
However, given the difficulty in predicting the path of economic recovery, our credit reserve remains at over $1 billion.
We are staying close to our customers in addressing their needs.
At the current level, we believe our reserves are appropriate and that we are well positioned.
Non-interest income increased as customer activity began to rebound, including continued strong contribution from our card platform.
Of note, following robust activity in the second quarter, derivative income declined $10 million.
We have continued to maintain our expense discipline.
Excluding the impact of deferred comp and an increase in charitable contributions, expenses declined.
Our capital remained strong with an estimated CET1 of 10.3%.
We remain focused on deploying our capital to support growth, while maintaining our very attractive competitive dividend.
Turning to Slide 4.
Average loans decreased $1.5 billion, which compares favorably to results for the industry as indicated by the H8 data for large banks.
As Curt mentioned, National Dealer declined $910 million due to low inventory levels impacting floor plan loans.
As far as corporate banking, you may recall that large companies drew on lines earlier this year to build liquidity buffers in a time of great uncertainty.
This resulted in an increase of nearly $800 million in second quarter average balances.
Corporate banking line utilization has returned to pre-pandemic levels with average balances down nearly $500 million in the third quarter.
General middle market loans declined about $400 million, while deposits increased nearly $2 billion.
Customers have been prudently cutting cost as well as reducing working capital and capex requirements to improve their cash flow in this challenging environment.
For the portfolio as a whole, line utilization decreased to 47% at period end.
On the other hand, with full quarter effect of PPP, loans grew in business banking and the small business segment captured in retail banking.
Also, our Mortgage Banker business, which serves mortgage companies, was at an all time high, increasing over $300 million due to very robust refi and home sale activity.
Loan yields were 3.13%, a decrease of 13 basis points from the second quarter.
Lower rates were the major driver.
One month LIBOR, the rate we are most sensitive to, declined 19 basis points.
This was partly offset by pricing actions we are taking, particularly adding LIBOR floors when possible as loans renew.
A mix shift in balances, including the full quarter impact of lower yielding PPP loans, also had a negative impact on yields.
Deposits increased 7% or $4.5 billion to a new record of $68.8 billion, as shown on Slide 5.
The larger driver continues to be non-interest-bearing deposits and growth has been broad-based with increases in nearly every business line.
As Curt mentioned, customers are conserving and maintaining excess cash balances.
Period end deposits increased over $700 million.
The largest contributor was technology and life sciences as robust fundraising added liquidity and customers reduced cash burn.
With strong deposit growth, our loan-to-deposit ratio decreased to 76%.
The average cost of interest-bearing deposits was 17 basis points, a decrease of nine basis points from the second quarter.
Our prudent management of relationship pricing in this low rate environment, our large proportion of non-interest-bearing deposits as well as the floating rate nature of our wholesale funding drove our total funding cost only 14 basis points for the quarter.
As you can see on Slide 6, we've put some of our excess liquidity to work by increasing the size of the portfolio.
We added $1.75 billion in treasuries and $500 million in mortgage-backed securities.
In addition, we continue to reinvest prepays, which remained elevated at around $1 billion for the quarter.
Yields on recent purchases have been around 140 basis points.
The additional securities combined with lower rates on the replacement of prepays resulted in the yield on the portfolio declining to 2.13%.
Of note, we have not seen a significant impact on the portfolio's duration or the unamortized premium, which remains relatively small.
Turning to Slide 7.
Net interest income declined $13 million to $458 million and the net interest margin was 2.33%, a decline of 17 basis points relative to the second quarter.
The major factors were lower rates, which had a negative impact of $15 million or seven basis points in the margin, and the increase in excess liquidity reduced the margin by nine basis points.
Taking a look at the details.
Interest income on loans declined $26 million and reduced the margin 13 basis points.
Lower interest rates on loans alone had an impact of $21 million and 11 basis points in the margin.
Lower balances had a $14 million impact, and the mix shift in portfolio, including the full quarter of lower yielding PPP loans had a four basis point impact on the margin.
Partly offsetting this were higher loan fees in the margin, primarily PPP-related as well as one additional day in the quarter.
As discussed on the previous slide, we had lower yields and higher balances in our securities portfolio, which together had a $2 million and two basis point negative impact.
Higher deposits of the Fed added $1 million, but had a negative impact of nine basis points on the margin.
Deposit cost declined by $5 million and added three basis points to the margin, primarily a result of a prudent management of deposit pricing, as I previously mentioned.
Finally, with a reduction in balances and lower rates, wholesale funding cost declined by $9 million, adding four basis points to the margin.
We received the full quarter benefit of debt repayments we made in the second quarter, and we prepaid $750 million in FHLB advances in July and August.
As a reminder, given the nature of our portfolio, our loans reprice very quickly.
So the bulk of the impact from lower rates has now been absorbed.
Also, we continue to closely monitor the competitive environment and our liquidity position as we manage deposit pricing.
Overall, credit quality was strong, as shown on Slide 8.
Net charge-offs were $33 million or 26 basis points, including recoveries of $20 million.
Criticized loans remained relatively stable with an increase of only $27 million and comprised 6.5% of the total portfolio.
Non-performing loans remained low at 62 basis points, and the bulk of the $54 million increase in the third quarter was attributed to energy loans.
In summary, we are leveraging our experience and expertise working closely with our customers and carefully reviewing their current and projected financial performance.
We have adjusted risk ratings as appropriate.
We started this cycle from a position of strength with very low non-performing and criticized loans, and migration so far has been manageable.
Turning to Slide 9.
The economy began to improve to the quarter.
However, the path to full recovery remains uncertain due to the unprecedented impacts of the COVID-19 pandemic.
For this reason, our CECL modeling in late third -- in the third quarter did not significantly change and included the recession that we have been experiencing, followed by a slow recovery.
More severe assumptions were used to inform the qualitative adjustments made for certain segments.
This combined with the reduction in loan balances, resulted in a slight decrease in our allowance for credit losses, which remains above $1 billion.
Our credit reserve ratio was 2.14%, excluding PPP loans.
Our credit reserve coverage for NPLs was strong at 3.2 times.
Again, we are well positioned with a relatively high credit reserve and low non-performing assets, as illustrated.
We believe our disciplined underwriting and diverse portfolio are assisting us in managing through this pandemic recession.
Energy loans are outlined on Slide 10.
They decreased $251 million to $1.8 billion at quarter end and represent 3.5% of our total loans.
E&P loans make up nearly 80% of the energy portfolio.
And energy services, which is considered the riskiest segment, was only $46 million.
The allocation of reserves to energy loans remained above 10%.
While non-accrual loans increased, criticized loans decreased $102 million and net charge-offs decreased to $9 million.
Charge-offs are net of $14 million in recoveries, which are unlikely to repeat in the near-term.
Fall redeterminations are just beginning, and we expect a small increase in the borrowing bases as higher energy prices were offset by lower production inventory.
With more than 40 years of serving this industry, we have deep expertise and remain focused on working with our energy customers as they navigate the cycle.
Slide 11 provides detail on segments that we believe pose higher risk in the current environment.
Note, we continue to review the portfolio refining our assessment.
As a result, we have removed casinos and sports franchises from this group as we no longer see elevated risk.
That aside, period end loans in the social distancing segment decreased $145 million or 5%.
As expected, criticized loans increased $102 million, yet remained manageable at 10% of the segment and non-accruals remained very low.
We believe we are well reserved as we have applied a more severe economic forecast to the segment.
We have deep expertise and a long history of working in the cyclical automotive sector.
Production has been ramping back up and auto sales have rebounded.
Similar to the social distancing segment, while loans decreased about $250 million, the criticized portion increased, yet non-accruals decreased and remained low.
Our leverage loans tend to be with middle market relationship-based customers with sponsors, management teams and industries we know well, and we avoid the covenant-light deals.
Balances increased to $85 million and criticized and non-accrual loans were slightly higher.
As far as payment deferrals, they provided a cushion as customers adjusted to the environment.
Now that they've acclimated, initial deferrals have expired, a new request of a nominal.
Total deferrals at September 30 dropped only 70 basis points of total loans.
Non-interest income increased $5 million, as outlined on Slide 12.
Improved economic conditions had a positive impact on deposit service charges and card fees.
Deposit service charges were up $5 million with increased cash management activity.
Also, card fees remained very strong and increased $3 million due to higher consumer volumes and merchant activity spurred by the economic stimulus as well as changes in customer behavior related to COVID.
Commercial lending fees grew with increased syndication activity and unutilized line fees.
As expected, customer derivative income declined following very robust activity in the second quarter, which related to the rapid decline in interest rates and volatile energy prices that have since stabilized.
Derivative income also included a $6 million unfavorable credit valuation adjustment compared to an unfavorable adjustment of $3 million in the second quarter.
Securities trading income decreased $2 million, but remained at an elevated level and reflects fair market adjustments for investments we hold related to our technology and life sciences business.
Similarly, investment banking fees declined, yet continue to be relatively strong.
Deferred comp asset returns were $8 million, a $6 million increase from last quarter, which is offsetting non-interest expenses.
Also, bank-owned life insurance increased with the receipt of the annual dividend.
Turning to expenses on Slide 13.
Salaries and benefits increased $8 million.
This included the increase in deferred comp of $6 million that I just mentioned as well as seasonally higher staff insurance.
A catch up on maintenance projects, which we expect to continue in the fourth quarter as well as seasonal taxes resulted in an increase in occupancy costs.
As previously announced, we increased our charitable contributions to assist businesses and communities impacted by the pandemic.
Since early March, Comerica, together with Comerica Charitable Foundation, has distributed over $9 million to over 150 non-profit and other community service organizations.
Outside processing decreased $4 million, primarily related to lower PPP loan initiation volumes.
In addition, operational losses and legal-related costs declined $3 million.
Our expense discipline is well ingrained in our company and is assisting us in navigating this low rate environment as we invest for the future.
Our capital levels remained strong, increasing to an estimated CET1 of 10.26%, as shown on Slide 14.
We were focused on maintaining our attractive dividend and deploying our capital to drive growth, while we maintain strong capital levels with the CET1 target of 10%.
In addition, the dividend is supported by strong holding company cash.
Slide 15 provides for our outlook for the fourth quarter relative to the third quarter.
We are assuming a continued gradual improvement in GDP and unemployment.
Also, while we do expect to see some modest forgiveness in PPP loans by the end of the year, there is a great deal of uncertainty.
Therefore, we exclude any impact from forgiveness on loans, net interest income and expenses from this outlook.
Starting with loans, we expect National Dealer balances to increase as auto inventory levels begin to rebuild.
Mortgage Banker is expected to decline somewhat from its record high with seasonally lower purchase and refi volumes.
In addition, we believe the recent stabilization of balances that we've seen in certain business lines, such as the middle market, large corporate and energy, should continue.
However, on a quarter-over-quarter basis, average balances in these businesses are expected to be lower.
We expect average deposits to remain strong and stable as customers continue to carefully manage their liquidity.
This expectation includes -- excludes the benefit from any further government stimulus programs.
Overall, net interest income is expected to be relatively stable.
As we've already absorbed the bulk of the effect from the decline in rates, we estimate the net effect of lower rates alone will be $5 million or less.
The impact from reduced loan balances, lower interest rates on loans and lower yields on securities is expected to be mostly offset by additional rate floors on loans, a decrease in deposit rates to an average of 14 basis points, as well as the full quarter benefit of third quarter actions to increase our securities portfolio and reduced wholesale borrowings.
Again, this outlook excludes any benefit from PPP loan forgiveness.
Credit quality is expected to be solid with net charge-offs increasing from the low third quarter level, which did include strong recoveries.
Although the pace of the economic recovery remains uncertain, with our credit reserve at about 2% of loans in the third quarter, we believe we are well positioned to manage through it.
We expect non-interest income to decline as we do not expect the third quarter levels of deferred comp, securities trading income or BOLI to repeat.
We believe several customer-driven fee categories should grow with improving economic conditions.
But this is expected to be offset by card volume decreasing as recent elevated activity receipts.
As far as expenses, we expect a rise in technology costs as we catch up on initiatives that were delayed due to COVID.
We are committed to investing in our futures that we are well positioned coming out of the pandemic.
In addition, we expect an increase related to seasonal staff insurance.
Mostly offsetting these increases, charitable giving should revert to a normal level, and we do not expect the level of deferred comp to repeat.
We continue to focus on controlling expenses as we closely manage discretionary spending.
Finally, our capital levels are healthy, and we remain focused on managing our capital with the goal of providing an attractive return to our shareholders.
I will close with Slide 16.
Over our 170-year history, Comerica has successfully managed through many challenging times.
Using our experience and expertise to help our customers and communities navigate stressful situations and achieve long-term success is at the heart of Comerica's relationship banking strategy.
The unwavering dedication of our team to assist our customers as well as support each other and our communities continues to be a source of pride.
Our long-standing corporate mission is to attain balanced growth and profitability by providing a higher level of banking.
Fundamental to our success in accomplishing this mission is our key strengths, which are outlined here.
We have long-tenured employees who have deep expertise in the industries they serve.
We have a strong presence in the major metropolitan areas of Texas, California and Michigan, and these markets provide significant growth opportunities along with customer diversity.
There are abundant collaboration opportunities among our three divisions; Commercial Banking, Retail Banking and Wealth Management.
Our robust leading-edge cash management suite continues to evolve to meet the ever-changing needs of our customers.
We have a strong credit culture.
Our consistent conservative underwriting approach and prudent customer selection resulted in superior credit performance through the last recession.
It also -- it is also assisting us in weathering the current environment, as evidenced by our strong credit metrics this quarter.
We are committed to maintaining our expense discipline while investing for the future.
Finally, our capital position is strong.
And our first priority is to use it to support growth, while providing an attractive return to our shareholders.
Now we'd be happy to take questions.
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third quarter 2020 net income of $211 million, $1.44 per share.
qtrly net interest income decreased $13 million to $458 million versus q2.
qtrly provision for credit losses decreased $133 million to $5 million versus q2.
sees q4 net interest income relatively stable versus q3.
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As we all know, 2020 was a very trying year.
And I could not be more proud of the unwavering commitment of our team to serve our customers, communities and each other during this unprecedented time.
It has been truly remarkable.
When I assumed the role of Chairman in January, the fundamentals of the economy were strong.
And I was looking forward to working with our executive team to execute our relationship banking strategy.
Then in March, our focus shifted due to COVID.
Despite the many challenges the pandemic posed, we have proven our resilience and achieved many important accomplishments along the way.
This includes the Bank and the Comerica Charitable Foundation, together providing $11 million in assistance to local communities and businesses.
We funded $3.9 billion in PPP loans to small and medium-sized companies.
We were able to quickly enable the majority of our employees to work remotely and introduce programs to provide support, such as Promise Pay and Dependent Care Stipends.
As consumers' desire to utilize digital channels increased, we enhanced our online capabilities for deposit accounts as well as loan originations.
Also, we achieved our 2020 environmental goals set in 2012 to meaningfully reduce our water, waste, paper and GHG emissions.
Our commitment to corporate responsibility was recognized, including receiving high marks from Newsweek, DiversityInc.
, Civic 50, CDP and Corporate Nights.
The compassion and tireless efforts of our colleagues across the Bank has allowed Comerica to persevere and remain in a strong position as we move forward.
Slide 4 provides a review of our 2020 financial results, which included solid loan performance and a record level of deposits.
This growth, combined with prudent management of loan and deposit pricing and action we took to deploy excess liquidity, helped offset the pressure of rates dropping to ultra-low levels.
In light of the swift deterioration of the economy, we significantly increased our credit reserve and took a large provision in the first quarter.
While we saw some negative credit migration through the year, it has been manageable.
And our net charge-offs for the year were 38 basis points or 14 basis points excluding energy.
A true testament to our relationship banking strategy and deep credit experience.
Card fees and securities trading income were strong, while other fees such as deposit service charges and commercial lending fees were impacted by the slowdown in economic activity.
Expenses remained well controlled and included COVID-related cost.
We maintained our strong capital levels and booked -- our book value grew 7% to over $55 per share.
In summary, a solid performance, particularly considering the difficult environment.
Our fourth quarter performance is outlined on Slide 5.
We generated earnings of $215 million or $1.49 per share, a 3% increase over the third quarter, driven by an increase in revenue and strong credit quality.
Compared to the third quarter, loans essentially performed as we expected.
While lower on a quarter-over-quarter basis, average loans increased in December relative to November by nearly $300 million excluding PPP loan repayments.
Our loan pipeline continue to grow through the year to pre-COVID levels at year end.
Average deposits increased by nearly $1.5 billion to an all-time high with 55% of the growth derived from non-interest-bearing accounts.
Customers continue to prudently manage their cash, cutting costs and reducing leverage.
Yet, they remained cautiously optimistic that the economy will pick up in the back half of this year.
Net interest income increased $11 million benefiting from our continued careful management of loan-to-deposit pricing, combined with the contribution from fees related to PPP loan forgiveness.
This was partly offset by lower loan balances.
In addition, lower yields on our securities portfolio were mostly offset by actions we took in the third quarter to deploy a portion of excess liquidity by increasing the size of the portfolio.
As far as credit, our metrics remained strong and our provision was a credit of $17 million.
Criticized loans declined and net charge-offs were only 22 basis points.
Positive portfolio migration and the slight improvement in the economic forecast resulted in a reduction of the credit reserve to just under $1 billion or nearly three times non-performing assets.
Through the cycles, our credit performance relative to the industry has been a key differentiator.
And I believe we will continue to outperform.
Non-interest income increased $30 million or 5% as customer activity continued to rebound.
This included strong derivative income and commercial lending fees.
We continue to maintain our expense discipline as we invest for the future.
While expenses were higher in the fourth quarter, this was primarily driven by performance incentives as well as outside process related to our card platform.
Our capital levels remained strong.
Our CET1 ratio increased to 10.35%, above our target of 10%.
As always, our priority is to use our capital to support our customers and drive growth, while providing an attractive return to our shareholders.
Turning to Slide 6.
Average loans decreased approximately $600 million or 1%, which compared favorably to the industry HA data.
Loans in Corporate Banking and General Middle Market decreased as customers are performing well, prudently managing their business to increase cash flow and reduce debt.
For the fourth consecutive quarter, energy loans decreased and are at the lowest level since 2011.
The U.S. rig count is less than half of what it was a year ago.
However, it has been gradually increasing since late summer as oil prices began to recover.
Technology and Life Sciences loans declined about $180 million, mainly due to M&A and increased liquidity, driven by fundraising activity and companies reducing cash burn.
Equity Funds Services, which provides capital call lines to investment companies increased $244 million as activity has picked up with new fund formation.
National Dealer increased $190 million as inventory levels are rebuilding, yet remains $2 billion below fourth quarter 2019.
Mortgage Banker reached a new record with strong activity in both refi and home sales.
Period end loans were stable and included a decline in PPP balances of $298 million, primarily due to loan forgiveness.
Line utilization at year end for the total portfolio remained relatively low at 48%.
Loan yields increased seven basis points with accelerated fees from PPP forgiveness and continued pricing actions, particularly adding LIBOR floors when possible as loans renew.
Average deposits increased 2% or $1.5 billion to a new record of $70.2 billion, as shown on Slide 7.
The largest driver continues to be non-interest-bearing deposits and growth has been broad-based with increases in nearly every business line.
Customers continue to conserve and maintain excess cash balances.
Period end deposits increased over $4.4 billion.
Timing of monthly benefit activity in our government prepaid card business increased balances by $2.2 billion at quarter end.
However, this does not include the latest stimulus payments, which were received in early January.
With strong deposit growth, our loan-to-deposit ratio decreased to 72%.
The average cost from interest-bearing deposits reached an all-time low of 11 basis points, a decrease of six basis points from the third quarter and our total funding cost fell to only 10 basis points.
As you can see on Slide 8, the average balance of the securities portfolio increased.
This was due to the third quarter purchase of $2.25 billion in additional securities, primarily treasuries, as we took some action to put some of our excess liquidity to work.
The additional securities combined with lower rates on the replacement of prepays, which totaled about $1 billion, resulted in the yield on the portfolio declining to 1.95%.
We expect repayments of MBS to continue to be about $1 billion per quarter and yields on reinvestments to be in the low-to-mid 100 basis point range.
Turning to Slide 9.
Net interest income increased $11 million to $469 million and the net interest margin was up three basis points to 2.36%.
Interest income on loans increased $6 million, adding four basis points to the margin.
Higher fees, mostly related to PPP loan forgiveness and continued pricing actions as loans renew, together added $10 million and four basis points to the margin.
Other portfolio dynamics, including higher non-accrual income, added $1 million.
The decrease in loans had a $5 million unfavorable impact.
Lower securities yields had a $6 million or three basis point negative impact.
This was mostly offset by the higher balance, which added $5 million.
Average balances of the Fed increased over $500 million, impacting the margin by one basis point.
Our extraordinarily high Fed balances of $13 billion continue to weigh heavily on the margin with the gross impact of approximately 43 basis points.
Finally, prudent management of deposit pricing added $5 million and three basis points to the margin and lower rates on wholesale funding added $1 million.
Given the nature of our portfolio, our loans reprice very quickly as rates dropped earlier last year, so the bulk of the impact from lower rates has been absorbed.
Also, while deposit rates are at record lows, we continue to manage deposit pricing with a close eye in the competitive environment and our liquidity position.
Overall, credit quality was strong, as shown on Slide 10.
Gross charge-offs were only $39 million, a decrease of $14 million from the third quarter.
Net charge-offs were $29 million or 22 basis points.
Non-performing assets increased $24 million, yet remained below our historical norm at 69 basis points of total loans.
Inflows to non-accrual were about half of the amount of the third quarter and the lowest level of any quarter since the pandemic began.
Criticized loans declined $459 million and comprised 6% of the total portfolio.
We believe our disciplined underwriting and diverse portfolio are assisting us in managing through the pandemic conditions.
Positive migration in the portfolio combined with a modestly improved economic outlook resulted in a small decrease in our allowance for credit losses.
As the path to full economic recovery remains uncertain due to the unprecedented challenges of the COVID-19 pandemic, our reserve ratio remains elevated at 1.90% or 2.03%, excluding PPP loans.
We are well positioned with a relatively high credit reserve and overall improving credit quality.
Slide 11 provides detail on segments that we believe pose higher risk in the current environment.
Period end loans in the social distancing segment declined slightly.
Criticized loans were stable and non-accruals remain under 1%.
This segment has performed better than expected, but issues can be lumpy and sudden and resulted in net charge-offs of $21 million in the fourth quarter.
The new round of PPP will certainly be helpful for customers that are challenged by the current environment.
Energy loans decreased 13% to $1.6 billion at quarter end, representing 3% of our total loans.
Oil prices have increased and credit quality has improved with reductions in criticized, non-accruals and net charge-offs.
We have seen a little more capital markets activity and fall redeterminations resulted in only a slight decrease in borrowing basis due to lower reserves.
Additional information can be found in the appendix.
While we are pleased with the performance of these segments, we have applied a more severe economic forecast to them, and believe we are well reserved.
Non-interest income increased $13 million, as outlined on Slide 12, continuing the positive trend we've seen since post the shutdown of the economy earlier last year.
Fourth quarter includes increased customer activity in most categories.
Customer derivative income increased $8 million with higher volume due to interest rate swaps and energy hedges, combined with the change in the impact from the credit valuation adjustment.
Specifically, there was an unfavorable adjustment of $6 million in the third quarter and a favorable adjustment of less than $1 million in the fourth quarter.
Commercial lending fees increased $5 million with the seasonal pickup in syndication activity and higher unutilized line fees.
We had smaller increases in fiduciary, foreign exchange and letters of credit.
Also, card fees remained very strong due to government card and merchant activity spurred by the economic stimulus and changes in customer behavior related to the COVID environment.
Securities trading income, which includes fair market adjustments for investments we hold related to our Technology and Life Sciences business, decreased $5 million from elevated levels generated over the last couple of quarters.
Note, deferred comp asset returns were $9 million, a $1 million increase from the third quarter and are offsetting non-interest expenses.
All in all, a strong quarter for fee income.
Turning to expenses on Slide 13.
Salaries and benefits increased $14 million with higher performance-based incentives, severance, staff insurance expense and technology-related labor.
Note that on a full year basis, salary and benefit expense was stable with a reduction in incentive compensation, offsetting annual merit, higher deferred comp and COVID-related costs.
We realized a $7 million increase in outside processing due to card activity, technology spend as well as PPP program costs.
Occupancy increased $2 million due to a catch-up in maintenance projects that were delayed due to COVID as well as seasonal expenses.
There is also a seasonal increase in advertising expense.
Our strong expense discipline is well ingrained and is assisting us in navigating this low rate environment as we invest for the future.
Our capital levels remained strong, as shown on Slide 14.
Our CET1 ratio increased to an estimated 10.35%, above our target of 10%.
As always, our priority is to use our capital to support our customers and drive growth, while providing an attractive return to our shareholders.
In this regard, we've maintained a very competitive dividend yield.
As far as share repurchases, we have a long track record of actively managing our capital and returning excess capital generated to shareholders.
As we sit here today, a great deal of uncertainty remains about the ultimate pace of the economic recovery, whether it be faster or slower than economists forecast.
For that reason, we have paused for share repurchases and look forward to starting the program as soon as we deem it prudent to do so.
Slide 15 provides our outlook for the first quarter relative to the fourth quarter as well as some color in the year ahead.
In the first quarter, we expect National Dealer loans to continue to increase at a moderate pace as auto inventory rebuilds.
Also, middle market is expected to grow as a result of increased economic activity.
However, this will be more than offset by Mortgage Banker declining from its record high due to seasonally lower purchase and refi volumes.
Energy is expected to decrease due to higher oil prices driving improved cash flow and capital markets activity.
As far as PPP loans, we expect the pace of loan forgiveness could potentially exceed the second round of fundings.
Looking past the first quarter, excluding PPP loan activity and based on improving economic conditions, we expect loans to grow throughout the year.
We expect average deposits to remain strong in the first quarter as customers continue to carefully manage their liquidity.
As far as net interest income, continued management of loan and deposit pricing is expected to be accretive, albeit to a lesser degree than we've seen so far.
We are currently in the process of deploying some excess liquidity by repaying $2.8 billion of FHLB advances over an eight week period, which will provide a modest lift.
These benefits are expected to be more than offset by reduced loan balances, lower yields on securities, slightly lower LIBOR as well as two fewer days in the quarter.
As we move through the year, assuming there is no change from rates that we experienced in the fourth quarter, we expect quarterly pressure on securities yields and swap maturities to mostly -- to be mostly offset by loan growth, excluding PPP impacts.
We expect net charge-offs to increase from low levels we've seen recently.
However, with our credit reserve at year end at over 2% of loans, excluding PPP, we believe we are well positioned to manage through this period of economic uncertainty.
We expect non-interest income in the first quarter to benefit from higher deposit service charges, fiduciary and brokerage fees.
As deferred comp is difficult to predict, we assume it will not be repeated.
We expect a seasonal decline in syndication activity.
Also, card, warrants and securities trading income are expected to decline from elevated levels.
As we progress through the year, we believe that customer-driven fee categories in general should grow with improving economic conditions.
We expect expenses to be lower in the first quarter.
Our pension expense is expected to decline $9 million in the first quarter to get to the new run rate for 2021.
The decline is primarily due to strong investment performance in 2020.
As I mentioned, we do not forecast deferred comp of $9 million to repeat.
Also, marketing and occupancy expenses are expected to be seasonally lower, and there are two less days in the quarter.
Partly offsetting all of this, first quarter includes annual stock comp and associated higher payroll taxes.
We remain focused on maintaining our expense discipline while we invest in the future.
Therefore, on a full year basis, we expect higher salary expense related to normal merit and incentive comp as well as higher tech spend will be mostly offset by lower pension and deferred comp returns.
We expect a 22% tax rate, excluding discrete items.
Finally, as mentioned on the previous slide, we remain focused on maintaining our strong capital levels and providing an attractive return to shareholders.
While difficult and uncertain conditions persist, I am confident that our team will continue to adapt and thrive as we have over the past year.
We expect the economy will improve in 2021.
We believe firming trade and manufacturing conditions, increasing business and consumer confidence as well as pent-up demand will support solid economic growth, particularly in the back half of the year.
Comerica has a long history of successfully managing through challenging times.
We have demonstrated our resiliency and unwavering dedication to provide a high level of customer service as we navigate the COVID pandemic.
We maintain a culture that drives continuous efficiency improvement.
We believe this will assist us in preserving our cost base as the economy improves, and we continue to invest in our future.
Our discipline credit culture and strong capital base continues to serve us well.
Utilizing our deep expertise and experience to help our customers navigate these difficult times builds and solidifies long-term relationships.
These key strengths provide the foundation to continue to deliver long-term shareholder value.
This has been demonstrated by our ROE, which increased over 11% in the fourth quarter and our book value per share, which grew 7% over the past year as well as the current dividend yield, which remains above 4%.
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compname reports q4 net income of $1.49 per share.
q4 2020 net income $1.49 per share.
qtrly net interest income increased $11 million to $469 million.
q1 2021 average deposits to remain strong.
sees decline in net interest income with lower average loan balances, libor and security yields as well, in q1 2021 versus q4 2020.
qtrly provision for credit losses decreased $22 million to a benefit of $17 million versus q3.
q4 net interest income $469 million versus $544 million in q4 2019.
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I'd like to begin the call with a few highlights from CMC's historic fiscal 2021, then I'll turn comments to our fourth-quarter results before providing updates on our strategic projects and current market environment.
I'm pleased to report that fiscal 2021 marks the best financial performance in our company's 106-year history.
CMC generated its highest ever earnings from continuing operations, as well as record consolidated core EBITDA.
Both the North America and Europe segments also reported record results.
I'm also pleased to discuss our newly authorized share repurchase program and increased quarterly dividend payment, which should provide meaningful cash distributions to our shareholders.
CMC's exceptional fiscal-2021 performance translated to a return on invested capital of 14%, more than double the average for the three-year period proceeding our fiscal 2019 rebar asset acquisition.
We believe this sharp increase clearly demonstrates the dramatic strategic transformation CMC has undertaken in recent years.
Not only has our bottom line grown significantly, but the returns on capital deployed have created tremendous value for our shareholders.
We believe our record performance in fiscal 2021 was also a testament to our team's ability to respond quickly to robust market conditions.
CMC shipped more product out of our mills than ever before, with six of our 10 mills setting all-time shipment records and seven achieving best-ever production levels.
Our team continues to demonstrate their ability to optimize facilities and further increase the productivity of CMC's assets.
This showed at several plants as improvements across a variety of KPIs, including optimized melt yields and energy consumption and melt shops, higher tons per hour in rolling mills, as well as shortened lead times and shipping base.
Efficiency gains at our mills, combined with strong cost management throughout the entire North America vertical value chain, enabled CMC to achieve a year-over-year reduction in control of costs on a per ton basis.
To underscore the strength of this accomplishment, particularly with an inflationary environment, I would point out that over the same time frame, the Census Bureau's producer price index increased almost 10%.
It was also a time frame in which the entire U.S. economy was challenged by supply chain disruptions and labor shortages.
Late in fiscal 2021, CMC commissioned its third rolling line in Europe.
This is an important strategic growth investment we've been discussing for some time.
I'm pleased to share that the project was completed well under budget and production was ramped up more quickly than anticipated.
Both achievements are a testament to the capabilities of our Polish team.
This new asset ran at a high rate of production during the latter part of the fourth quarter and was a meaningful contributor to Europe's segment earnings.
During the year, CMC also made significant progress on our network optimization effort.
Following the full closure of CMC's former Steel California operations, we're now capturing an annual EBITDA benefit of approximately $25 million, while continuing to serve the West Coast market effectively and efficiently with bar source from lower-cost CMC mills.
When these actions complete, we are halfway to our stated target of $50 million on an annual optimization benefits.
On the sustainability front, CMC published its latest report in June, featuring enhanced disclosures and a commitment to achieve ambitious environmental goals by the year 2030.
CMC has been sustainable since its inception 106 years ago as a single location recycling operation in Dallas, Texas, and we have carried that legacy forward into the 21st century.
Slide 6 of the supplemental posted materials provides a clear illustration of CMC's industry leadership position as an environmental steward.
Going forward, we intend to publish our sustainability report on an annual basis, reflecting our commitment to transparency and timely measurement against our stated environmental goals.
Turning to fourth-quarter performance.
CMC generated earnings from continuing operations of $152.3 million or $1.24 per diluted share.
Excluding the impact of a small one-time charge related to the write down of a recycling asset, adjusted earnings from continuing operations were $154.2 million, or $1.26 per diluted share.
This level of adjusted earnings represents a 21% sequential increase and a 62% year-over-year increase, driven by strong margins on steel products and raw materials, as well as robust demand from nearly every end market we serve.
During the quarter, CMC generated an annualized return on invested capital of 20%, which is far in excess of our cost of capital and a clear indication of the economic value we are creating for our shareholders.
I would now like to provide a quick update on the status of CMC's key strategic growth projects.
I've already mentioned strong execution to date on both our network optimization initiative and the rolling line in Europe.
We are proud of the progress made on each.
The only comment to add is that during the two months of commercial production at our new rolling line, EBITDA on an annualized basis far exceeded the $20 million target used to justify the project.
The timing of start-up could not have been better.
We have stepped into a very strong market with both demand and pricing at healthy levels.
Construction of our revolutionary third micro mill the Arizona 2 remains on schedule for an early calendar 2023 start-up.
At this point, we have completed earthwork and now are pouring foundations and beginning vertical construction.
As a reminder, this plant will be the first micro mill in the world capable of producing merchant bar, as well as rebar.
It will also be the first in North America capable to connect directly to an on-site renewable energy source.
We believe these capabilities, combined with a micro mills inherent low-cost and low-carbon footprint, will define a new level of operational and environmental excellence in long product steel making.
When CMC announced the construction of Arizona 2 in August of 2020, we also indicated that a meaningful portion of the investment costs would be funded through the sale of the land underlying our former Steel California operations.
On September 29, CMC entered into an agreement to sell that parcel for roughly $300 million.
I would note that the sale price was much higher than the figure we estimated in August 2020 when we gave an expected net investment figure of $300 million for Arizona 2.
Paul will provide more detail on this in a moment.
Now turning to market conditions, first in North America.
We are seeing strong activity levels within nearly all our end markets.
At the mill level, demand for rebar, merchant bar and wire rod is robust.
Rebar is being supported by continued construction growth, particularly in our core geographies.
People are moving in, businesses are investing and state-funded infrastructure spending is healthy, which is reflected in residential, nonresidential and public construction spend data.
These factors have also benefited our shipments of wire rod.
In addition to construction, CMC's merchant product is sold into a number of end market applications and nearly all are growing on a year-over-year basis.
As you know, construction is by far CMC's largest end market, and our best leading indicator is our volume of downstream project bids.
Activity levels have been very strong for the last two quarters, driven by a good blend of private and public sector work.
Project owners are also awarding high volumes of new work, which has allowed CMC to replenish our downstream backlog following the lull that occurred in late 2020.
In fact, we've actually built backlog over the summer months, a period that typically entails a seasonal runoff.
Picture in Europe looks very similar to North America.
Construction activity is strong with new residential construction starts increasing by double-digit percentages on a year-over-year basis.
The Central European industrial sector continues to grow, highlighted by the current 14-month trend of expansionary PMI readings for both Poland and Germany.
CMC is now even better positioned to capitalize on this growth with production from our new rolling line, which allows our Polish operations to produce each of our three major product groups simultaneously.
Supply conditions in Central Europe are tight, which has driven margins sharply upward from the historic lows of fiscal 2020 and early fiscal 2021.
The new rate of $0.14 per share of CMC common stock is payable to stockholders of record on October 27, 2021.
The dividend will be paid on November 10, 2021.
Additionally, as announced yesterday, the board of directors also authorized a new share repurchase program of $350 million.
Paul will provide additional details regarding our capital allocation strategy during his remarks.
And with that as an overview, I will now turn the discussion over to Paul Lawrence, vice president and chief financial officer, to provide some more comments on the results for the quarter.
I'm pleased to review with you our outstanding fourth-quarter results.
As Barbara noted, we reported record earnings from continuing operations of $152.3 million or $1.24 per diluted share, more than double prior-year levels of $67.8 million and $0.56, respectively.
Results this quarter include a net after-tax charge of $1.9 million related to the write-down of recycling assets.
Excluding the impact of this item, adjusted earnings from continuing operations were $154.2 million or $1.26 per diluted share.
Core EBITDA from continuing operations was $255.9 million for the fourth quarter of 2021, up 45% from a year-ago period and 11% on a sequential basis.
Both of our North America and Europe segments contributed significantly to year-over-year earnings growth, while core EBITDA per ton of finished steel reached a record level of $155 per ton.
The fourth quarter marked the tenth consecutive quarter in which CMC generated an annualized return on invested capital at or above 10%, which is above our cost of capital.
Now I will review the results by segment.
North American segment recorded adjusted EBITDA of $212 million for the quarter, an all-time high, compared to adjusted EBITDA of $174.2 million in the same period last year.
The largest drivers of this 22% improvement were significant increase in margins on steel products and raw materials, as well as solid volume growth.
Partially offsetting these benefits was an increase in controllable costs on a per ton of finished steel basis.
Prior to the fourth quarter of fiscal '21, CMC had achieved seven consecutive quarters of year-over-year reductions to our controllable costs per ton.
Selling prices for steel products from our mills increased by $300 per ton on a year-over-year basis and $106 per ton sequentially.
Margin over scrap on steel products increased by $103 per ton from a year ago and $41 per ton sequentially.
The average selling price of downstream products increased by $44 per ton from the prior year, reaching $1,014.
This increase did not keep pace with underlying scrap costs leading to a year-over-year decline in margins.
At this point, I'd like to spend a moment to discuss the pricing dynamics of our downstream backlog.
The average price per ton of our downstream shipments is a function of the volumes and price points on the hundreds of fixed price projects that comprise the total backlog at any given time.
The average price of our total backlog will move up or down over time based on the new work we are awarded and the older work that is being completed.
Currently, we are in an environment in which our backlog is repricing upward with new work coming in at much higher prices than the completed work it is replacing, reflecting a margin above current spot rebar prices.
We expect this upward pricing trend in our backlog will translate into the average shipment price increasing throughout much of fiscal '22.
CMC does not give price guidance, but we can say absent a run-up of scrap cost, the margin benefit of our backlog repricing is expected to be significant in future periods.
Shipments of finished product in the fourth quarter increased 2% from a year ago.
Demand for rebar out of our mills remains strong, but as shipments declined modestly from the prior year due to a shift in our mix toward merchant and wire rod.
Volumes of merchant and other steel products hit a record level during the quarter, increasing 29% on a year-over-year basis and were 20% higher than the trailing three-year average.
Downstream product shipments were impacted by a reduced backlog we had at the beginning of the year and resulted in a 3% volume decline from the fourth quarter of fiscal 2020.
Barbara mentioned, our backlog was replenished during the latter half of fiscal '21 and has actually grown on a year-over-year basis for the past several months.
Turning to Slide 10 of the supplemental deck.
Our Europe segment generated record adjusted EBITDA of $67.7 million for the fourth quarter of 2021, compared to adjusted EBITDA of $22.9 million in the prior-year quarter.
Improvement was driven by expanded margins over scrap, strong volumes across our range of products and contributions from our new rolling line.
I should note that the prior-year period included a roughly $11 million energy credit that the current period does not.
We expect to receive a similar sized credit during the first quarter of fiscal '22.
Margins over scrap increased by $119 per ton on a year-over-year basis and were up $27 per ton from the prior quarter.
Tight market conditions provided the backdrop to achieve the segment's highest average selling price in more than a decade, reaching $763 per ton during the fourth quarter.
This level represented an increase of $317 per ton compared to a year ago and $99 per ton sequentially.
Europe volumes increased 21% compared to the prior year and reached their highest level on record.
The strength was broad-based with shipments of rebar, merchant bar and other steel products increasing by double-digit percentages on a year-over-year basis.
Polish construction market remains robust with new residential activity growing strongly.
Consumption of our merchant and wire rod products has been supported by an expanding Central European industrial sector.
As Barbara mentioned, the ramp-up of our third rolling mill helped CMC capitalize on these strong conditions and increased volumes during the quarter.
Turning to capital allocation and our balance sheet.
The new share repurchase program equates to roughly 9% of our market capitalization and will replace the previous program enacted in 2015.
These actions highlight the confidence that CMC's board and senior leadership have in the earnings capability of CMC, as well as our future prospects.
Our intention is to target a cash distribution to shareholders that represent a meaningful portion of free cash flow and is competitive with sector peers.
We plan on executing against this target by utilizing share repurchases to supplement our dividend payments.
We believe this approach will allow CMC's strategic flexibility in our deployment of capital, as well as provide a mechanism to directly return excess cash flow with shareholders during the periods of strong performance.
CMC's rebalanced capital allocation framework with its greater emphasis on cash distribution should in no way impede on our first priority, which is pursuing value-accretive growth.
We expect to fully fund our current strategic growth projects with organic cash generation while simultaneously providing enhanced cash returns to shareholders and maintaining a high-quality balance sheet.
Our capital allocation priorities are laid out explicitly in simple terms on Slide 14.
We have proven ourselves as excellent stewards of capital and generator of economic value.
We believe our best use of capital is the execution of attractive value-creating growth.
As we look beyond the completion of the slate of strategic initiatives outlined during our investor day last year, we are encouraged by the pipeline of attractive strategic growth projects that are currently being explored.
However, we believe that given the robust and stable cash flows we expect to generate through the cycle, CMC will have the ability to both fund attractive growth and return elevated levels of cash to our shareholders.
We always look to optimize our debt costs.
However, given the current slate of our balance sheet, we do not believe delevering is in the best advantageous strategy to us at this time.
Overarching our entire capital allocation strategy is our objective to maintain a strong balance sheet that provides strategic flexibility and gives CMC the wherewithal to navigate any economic environment.
Moving to the balance sheet.
As of August 31, 2021, cash and cash equivalents totaled $498 million.
In addition, we had approximately $699 million of availability under our credit and accounts receivable programs.
During the quarter, we generated $134 million of cash from operations despite a $48 million increase in working capital.
The rise in working capital was driven by the significant increase in both scrap input costs and average selling prices.
Looking past these factors, our days of working capital have decreased from a year ago.
Our leverage metrics remain attractive, and we have improved significantly over the last two fiscal years.
As can be seen on Slide 17, our net debt-to-EBITDA ratio now sits at just 0.8%, while our net debt to capitalization is at 17%.
We believe a robust balance sheet and overall financial strength provides us the flexibility to fund our strategic growth projects, navigate economic uncertainties and pursue opportunistic M&A while returning cash to shareholders.
CMC's effective tax rate for the quarter was 21%.
For the year, our effective tax rate was 22.7%.
Absent enactment of any new corporate tax legislation, we forecast our tax rate to be between 25% and 26% in fiscal '22.
Lastly, I would like to provide CMC's fiscal '22 capital spending outlook.
We currently expect to invest between $450 million to $500 million this year with a little over half of which can be attributed to Arizona 2.
We are entering the middle phase of mill construction when investment and on-site activity is anticipated to be the highest.
As we indicated in the past, proceeds from the sale of our Rancho Cucamonga land are expected to be used to offset much of the cost of the state-of-the-art mill.
Total gross investment for Arizona 2 is forecast to be approximately $500 million.
Against which, we'll apply roughly $260 million net after-tax proceeds from the land transaction.
This nets out to be $240 million of spend for the new mill, compared to the $300 million net investment figure we had previously provided.
The difference as Barbara previously mentioned, is due to the higher-than-expected valuation on the land sale.
This concludes my remarks, and now I will turn back to Barbara for the outlook.
We entered fiscal 2022 confident about what lies ahead.
Based on our current view of the marketplace and our internal indicators, we anticipate continued strong financial performance.
Signs point to healthy demand in our key end markets, and we expect supply/demand conditions to remain favorable, supporting good margin levels.
Additionally, several of the sector trends we've discussed previously are likely to provide tailwinds in an already growing domestic construction market.
These trends include the regional population migration, which has been occurring for many years, but accelerated over the course of the pandemic, as well as supply chain hardening.
Exceptionally strong new single-family construction activity in CMC's core geographies is likely to be followed by the buildout by municipalities and private businesses of local infrastructure to support expanded or newly formed communities.
The positive tone of our outlook is mirrored by the latest cement consumption forecast from the Portland Cement Association and consensus nonresidential forecasts compiled by the American Institute of Architects.
The PCA expects growth in cement consumption of 2.2% in fiscal 2022 and 1.4% in 2023.
The AIA consensus outlook for private nonresidential spending anticipates an increase of roughly 5% in 2022.
More near term, in looking to the first quarter of fiscal '22, we expect shipments to follow a typical seasonal trend, which has historically equated to a modest decline from fourth-quarter levels.
Margins on steel products, as well as controllable cost per ton should generally -- be generally consistent on a quarter-over-quarter basis.
At this time, we will now open the call to questions.
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q4 adjusted earnings per share $1.26 from continuing operations excluding items.
q4 earnings per share $1.24 from continuing operations.
anticipate strong operating and financial performance will continue in fiscal 2022.
declared quarterly dividend $0.14 per share of cmc common stock, represents 17% increase over previous dividend.
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If not, it may be found on our Investor Relations website at ir.
Our discussions today will include non-GAAP financial measures.
Our entire executive leadership team is available during the Q&A session.
Chipotle's third quarter results highlight strong momentum in our business, fueled by a multi-pronged growth strategy and a passionate team that's delighted to see more guests coming back into our restaurants.
We continue to retain about 80% of digital sales but have now recovered nearly 80% of in-restaurant sales.
While COVID impacts will likely persist for a few more quarters, we are hopeful that the worst is behind us and society can shortly return to a more normal environment.
For the quarter, we reported record quarterly sales of $2 billion, representing 21.9% year-over-year growth, which was fueled by a 15.1% increase in comparable restaurant sales.
Restaurant level margin of 23.5% was 400 basis points higher than the 19.5% we reported last year.
Earnings per share adjusted for unusual items of $7.02, representing an increase of 86.7% year-over-year.
Digital sales growth of 8.6% year-over-year, representing 42.8% of sales and we opened 41 new restaurants, including 36 with a Chipotlane.
And I'm pleased to report that Q4 is off to a great start.
These results highlight that our key strategies continue to resonate with guests and allow us to win today, while we create the future.
While we regularly get asked, what's next, I believe our current growth drivers have plenty of runway and will be critical to us reaching our longer-term goal of 6,000 restaurants in North America with AUVs above $3 million and improving returns on invested capital.
To remind everyone, we're focusing on five key areas.
Number one, opening and running successful restaurants with a strong culture that provides great food with integrity, while delivering exceptional in-restaurant and digital experiences.
Number two, utilizing a disciplined approach to creativity and innovation.
Number three, leveraging digital capabilities to drive productivity and expand access, convenience, and engagement.
Number four, engaging with customers through our loyalty program to drive transactions in frequency.
And last but certainly not least, number five, making the brand visible, relevant, and loved.
Let me now provide a brief update on each of these, starting with operations.
Well-trained and supported employees consistently preparing delicious food and delivering excellent guest experiences are at the heart of our success.
We're fortunate to have amazing employees at our restaurants who have stayed focused on safety, reliability, and excellent culinary, despite the dynamic and challenging environment.
We are extremely proud of Chipotle's world-class employee value proposition that includes industry-leading benefits, attractive wages, specialized training and development, access to education, and a transparent pathway to significant career advancement opportunities.
We believe these efforts are helping to attract and retain great employees, which is more important than ever given the challenging labor environment we're all experiencing today.
Over the past 18 months, we've made operational adjustments to adapt to our constantly changing environment in support of our in-restaurant business as well as our record-breaking digital business.
As a result, we've had to allocate labor as needed among the different roles, including the DML and the frontline, depending on available staff to accommodate the needs of our customers and our restaurant teams.
This flexibility has allowed us to keep our frontline open, given our ability to divert orders on the digital line as needed to overcome periodic staffing challenges.
This is part of the normal business balancing that occurs at the discretion of on-site managers and has not had a material impact on our business in the past.
This was through pre-pandemic and is more relevant now as dining room volumes recover.
The good news is that I believe we're finally getting back to pre-pandemic operations and I couldn't be more excited.
We're fortunate to have a dedicated digital make line and a dedicated dining room serving line.
Our frontline represented nearly 60% of our business or $1.1 billion of sales for the quarter.
It is big and it is growing.
We are committed to ensuring guests on the frontline get the customized meal they want, made with real ingredients, excellent culinary, and faster than anywhere else.
We still have some work to do, but our goal is to provide exceptional throughput as speed of service is a foundational element of convenience that our guests truly value.
Therefore, we are committed to teaching, training, and validating the five pillars of throughput every day during every shift to ensure we meet our high standards and provide a great guest experience.
While taking good care of guest is always a top priority, utilizing our stage gate process to continue innovating is critical to our growth.
The great news is that Chipotle's delicious food that you feel good about eating, which creates an emotional connection with our customers and they love to see ongoing innovation from us.
As a result, we introduced new menu items on a regular cadence as it helps bring in additional customers, drive frequency with existing users, and gives us an opportunity to create buzz around the brand.
Recently, we launched Smoked Brisket for limited time across all our U.S. and Canadian restaurants.
Our culinary team spent the last two years developing the perfect Smoked Brisket recipe that is unique to our brand and pairs flawlessly with our fresh, real ingredients.
This is our third new menu item this year, following on the success of our Cilantro-Lime Cauliflower Rice and handcrafted Quesadilla.
Early customer feedback on this entree, which is expected to last through November, has been very positive and we're delighted to see an increase in both check size and transactions.
Quesadillas, which we launched as a permanent digital exclusive offering in March, continues to perform well and is also helping attract new customers to Chipotle.
By the way, if you haven't had a chance to try the brisket quesadilla, you really are missing out.
And we're far from being done.
Plant-Based Chorizo is currently being tested in a couple of markets and our talented culinary team is in the early stages of developing other exciting menu items.
All that being said, our stage gate process is not limited to new menu innovations.
We use it for many parts of the business, including development.
As you know, we validated a new restaurant expansion in Canada earlier this year, impressive unit economics with AUVs and margins, equal to or above those in the U.S. led us to accelerate development in this market.
We've opened one new restaurant in Canada year-to-date and have several more planned before year-end, including our first ever Chipotlane that's scheduled to open next week.
Similarly, we are now in the early stages of using this process to learn, iterate, and eventually validate expansion in Western Europe.
COVID slowed our ability to execute several critical initiatives, however, with restrictions easing, we're making nice progress and have implemented some of our digital assets as well as begun to test alternative formats and explore new trade areas.
The recent openings have exceeded expectations.
So while we continue to view international expansion as a medium to longer-term opportunity, I remain quite optimistic about its future contributions to the Chipotle story.
A more near-term pillar of growth has been our ongoing digital transformation, which is helping Chipotle become a real food-focused digital lifestyle brand.
During the third quarter, digital sales grew nearly 9% year-over-year to $840 million and represented 43% of sales.
We're not surprised to see the mix moderate as the world continues to reopen.
However, we're pleased to see our digital sales dollars continue to grow despite lapping tough comparisons.
In fact, our year-to-date digital sales of nearly $2.7 billion are just slightly below the $2.8 billion we achieved during all of last year.
Digital is proving to be sticky as it's a frictionless and convenient experience that has been aided by continuous technology investments to improve operational execution, innovation, and the customer value proposition.
As a result of the pandemic, many new consumers were introduced to Chipotle via our digital channels and are now using us for alternative occasions.
The thing I love about having two separate businesses is that they serve different needs that will likely prove to be incremental and complementary over the long run.
This is reinforced by the fact that different guests are accessing Chipotle through different channels.
Currently, about 65% of our guest use in-restaurant as their main access point, nearly 20% use digital as their primary channel, and the remaining 15% to 20% use both channels.
We're encouraged by this dynamic as it gives us several future opportunities, including the ability to convert more of our in-restaurant guests into higher frequency digital users.
Not only are we pleased with the level of digital sales and overall mix, but we're also delighted to see that our highest margin transaction, digital pickup orders, is gaining traction.
This channel represented slightly more than half of digital sales in Q3.
As always, we're not being complacent and continue to look for ways to enhance convenience and access through alternate restaurant formats, digital-only menu offerings, and leveraging our large and growing loyalty program.
Speaking of the loyalty program, we're excited to have more than 24.5 million members, many of whom are new to the brand.
This gives us a large captive audience to engage with and distribute content that promotes our values, as well as motivates our super fans.
We continue to leverage our CRM sophistication by focusing a lot more on personalization and using predictive modeling to trigger journeys, primarily for new and lapsed customers.
These personalized messages are more brand-related as opposed to offers or discounts, which is allowing us to optimize program foundation and economics.
All these efforts, along with the use of enhanced analytics, are allowing us to consistently attract more visits from loyalty members than non-members.
No doubt the loyalty program has moved from a crawl to the walk stage, and we still have a lot of room to grow.
Offering new ways to engage with Chipotle is essential to the ongoing evolution of our digital business.
Our first enhancement was Rewards Exchange, which provides greater customization and flexibility to redeem rewards and allows guests to earn rewards faster.
More recently, we announced Extras, an exclusive feature that gamifies Chipotle rewards with personalized challenges to earn extra points and/or collect achievement badges in order to drive engagement.
As the program grows, so does our ability to provide sophisticated and relevant communications to our guests, which will ultimately deepen the relationship between members and the brand.
We are pleased with our progress to-date, but believe with ongoing investments and further leveraging of data-driven insights, we can get even better.
Amplifying all the growth initiatives I've mentioned thus far are the collective efforts of the marketing team, which are designed to make Chipotle more visible, more relevant, and more loved.
We believe that real food has the power to change the world and using custom creative across a wide variety of media channels that allow us to drive culture, drive difference, and ultimately, drive a purchase.
For example, we use numerous campaigns to stay relevant via important sporting events such as the basketball championships, where we hit $1 million worth of free burritos in our TV advertising.
We also utilize social media, including our website, to authentically highlight real food for real athletes during the broadcast from Tokyo.
And, of course, to celebrate the launch of Smoked Brisket, we offered an exclusive peek to our loyalty members prior to a full launch, supported by a media plan across online video, digital, and social media platforms as well as traditional TV spots.
All of these helped attract new guests into the Chipotle family as well as increase frequency of existing users.
We're fortunate to have an innovative marketing team that wants to be a leader, not a follower, and our marketing organization is built on a culture of accountability that encourages new ideas, that's committed to experimentation, and is ruthless on measuring returns, and isn't afraid to pivot to different opportunities if they don't perform to our high standards.
Every day this team is focused on driving sales today, while enhancing our brand for tomorrow.
Chipotle is committed to fostering a culture that values and champions our diversity, while leveraging the individual talents of all team members to grow our business, elevate our brand, and cultivate a better world.
Our team has proven their ability to be resilient and successfully execute against macro complexities.
As a result, I believe, we are better positioned to drive sustainable, long-term growth than we were before the pandemic, which makes me even more excited about what we can accomplish in the years ahead.
With that, here's Jack to walk you through the financials.
We're pleased to report solid third quarter results with sales growing 21.9% year-over-year to $2 billion as comp sales grew 15.1%.
Restaurant level margin of 23.5% expanded 400 basis points over last year, and earnings per share adjusted for unusual items was $7.02, representing 86.7% year-over-year growth.
The third quarter had a GAAP tax benefit that I'll discuss shortly, which is partially offset by expenses related to a previously disclosed modification to our 2018 performance share and transformation expenses, which netted to positively impact our earnings per share by $0.16 leading to GAAP earnings per share of $7.18.
As we look ahead to Q4, there remains uncertainty on several fronts, including COVID-related impacts as well as inflationary and staffing pressures.
But given our strong underlying business momentum, we expect our comp to be in the low-to-mid double digits, which is encouraging considering that will be about 200 basis points less than pricing contribution during Q4 versus Q3 as we've lap some of our delivery menu price increases.
And our brisket LTO will be for a partial quarter as compared to the full quarter of carne asada last year.
Let me now go through the P&L line items, beginning with cost of sales.
Our supply chain team has done an outstanding job, navigating the numerous industrywide disruption, which led to food costs being 30.3% in Q3, a decrease of 200 basis points from last year.
This is due primarily to leverage from menu price increases, which were partially offset by higher costs associated with beef and freight that unfortunately are continuing to worsen.
It's hard to predict how much of these headwinds will ultimately be temporary versus permanent but they are likely to persist for the foreseeable future.
In addition, Q4 will also include the higher cost brisket LTO, which collectively will result in our food costs being in the low-31% range for the quarter.
Labor costs for the third quarter were 25.8%, an increase of about 40 basis points from last year.
This increase was driven by our strategy to increase average nationwide wages to $15 per hour, which is partially offset by menu price increases, sales leverage, and a one-time employee retention credit.
Given ongoing elevated wage inflation and greater new unit openings, we expect labor costs to be in the mid-26% range in Q4.
Other operating costs for the quarter were 15.1%, a decrease of 170 basis points from last year due primarily to price and sales leverage.
Marketing and promo costs for the quarter were 2.4%, about 20 basis points lower than we spent last year.
While Q3 tends to be a seasonally lower advertising quarter, the timing of some initiatives also shifted into Q4 this year.
As a result, we anticipate marketing expense to be around 4% in Q4 to support Smoked Brisket and for the latest brand messaging under our Behind The Foil campaign.
For the full year 2021, marketing expense is expected to remain right about 3% of sales.
Overall, other operating costs are expected to be in the mid-16% range for the fourth quarter.
Looking at overall restaurant margins, we expect Q4 to be in the 20% to 21% range.
Our Q4 underlying margin would be around 22% when you normalize marketing spend and remove the temporary headwind from the brisket LTO.
And the remaining cost pressure will continue to evaluate and take appropriate actions on menu prices to offset any lasting impacts.
Our value proposition remains strong, which we believe gives us a lot of pricing power.
Despite these challenges, we remain confident in our ability to drive restaurant level margins higher as our average unit volumes increase.
G&A for the quarter was $146 million on a GAAP basis or $137 million on a non-GAAP basis, including $7.6 million for the previously mentioned modification for 2018 performance shares, and $1.6 million related to transformation and other expenses.
G&A also includes about $100 million in underlying G&A, about $28 million related to non-cash stock compensation, about $8.5 million related to higher performance-based bonus accruals and payroll taxes and equity vesting, and stock option exercises, and roughly, $600,000 related to our upcoming all-manager conference.
Looking to Q4, we expect our underlying G&A to be right around $101 million as we continue to make investments primarily intact to support ongoing growth.
We anticipate stock comp will likely be around $27 million in Q4, although this amount could move up or down based on our actual performance.
We also expect to recognize around $5.5 million related to performance-based bonus expense and employer taxes associated with shares that vest during the quarter as well as about $1.5 million related to our all-manager conference.
Our effective tax rate for Q3 was 14.7% on a GAAP basis and 19.7% on a non-GAAP basis.
Both rates benefited from our option exercises and share vesting at elevated stock prices.
In addition, our GAAP tax rate included a return to provision benefit for additional NOL generated on our 2020 federal income tax return and carried back to prior years.
For Q4, we continue to estimate our underlying effective tax rate to be in the 25% to 27% range, though it may vary based on discrete items.
Our balance sheet remains healthy as we ended Q3 with $1.2 billion in cash, restricted cash and investments with no debt along with a $500 million untapped revolver.
During the quarter, we repurchased $99 million of our stock at average price of $1,813 and we expect to continue using excess free cash flow to opportunistically repurchase our stock.
However, opening more Chipotles continues to be the best return we can generate.
During Q3, despite a few delays in opening timeline, we opened 41 new restaurants with 36 of these including a Chipotlane.
While we're experiencing construction inflationary pressures, subcontractor labor shortages, critical equipment shortages and landlord delivery delays, our development team is doing an excellent job opening these new restaurants.
In fact, we currently have more than 110 restaurants under construction, and while timing is somewhat unpredictable, this gives us confidence in ending the year at or slightly above the 200 new restaurants with now more than 75% including a Chipotlane versus our prior expectation of 70%.
Also, the team has done a nice job building a robust new unit pipeline, which we believe will allow us to accelerate openings in 2022.
But because of the challenges I just mentioned and how they could impact the timeline, we will provide 2022 opening guidance during our Q4 call.
As of September 30th, we had a total of 284 Chipotlanes, including 12 conversions and 8 relocations.
They continue to enhance access and convenience for our guests, while demonstrating stellar performance.
And while it's early days, Chipotlane conversions and relocations are yielding encouraging results.
We will leverage our stage gate process to learn and refine our strategic approach to accelerating our Chipotlane portfolio.
You can see why we remain optimistic about our future.
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compname reports q3 earnings per share of $7.18.
q3 earnings per share $7.18.
q3 revenue rose 21.9 percent to $2.0 billion.
q3 adjusted earnings per share $7.02 excluding items.
qtrly comparable restaurant sales increased 15.1%.
qtrly digital sales grew 8.6% year over year to $840.4 million.
qtrly food, beverage and packaging costs in q3 were 30.3% of revenue, decrease of 200 basis points compared to q3 of 2020.
qtrly restaurant level operating margin was 23.5%, an increase from 19.5% in q3 of 2020.
for q4 expect comparable restaurant sales to be in low to mid double-digits range.
sees q4 2021 comparable restaurant sales growth in low to mid double-digits range.
sees for fy 2021 at or slightly above 200 new restaurant openings.
sees an estimated underlying effective q4 2021 tax rate between 25% and 27% before discrete items.
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Such statements express our forecasts, expectations, hopes, beliefs and intentions on strategies regarding the future.
cummins.com, under the heading of Investors and Media.
I'll start with a summary of our second quarter financial results and our market trends by region and then finish with a discussion of our outlook for 2021.
Mark, will then take you through more details of both our second quarter financial performance, and our forecast for this year.
Demand remained strong in the second quarter, as the global economy continued to improve, driving strong sales growth across most businesses and regions, resulting in solid profitability.
We are encouraged by economic trends across a number of our key end markets, which point to strong demand for the remainder of this year, and extending into 2022.
In North America freight activity continues to grow, leading to elevated spot and contract rates and driving fleet profitability, and a rising backlog of truck orders.
Leading indicators for non-residential construction, continue to improve and fiscal support for investment and capital projects is robust, led by North America and Europe.
Iron ore, copper and thermal coal prices also remain high, supporting a positive outlook for mining.
Cummins is well positioned to benefit, as these markets gain momentum due to our leading global position across a number of end markets, and we continue to see demand our products outpace our competition.
Before getting into our results.
I want to take a moment to highlight a number of partnerships and strategic milestones, and the evolution of our next generation technologies.
In May, we formed a partnership with the Iberdrola, a leading global producer of renewable power to accelerate the global growth of business opportunities in the electrolyzer market, and especially in Europe with a focus on the Iberian Peninsula.
The Alliance will help position Cummins as a leading supplier of electrolyzer systems for large scale projects in Europe.
As part of our alliance, Cummins will be the electrolyzer supplier for a 230 megawatt project for a leading fertilizer producer that will serve as a benchmark for large PEM scale electrolysis globally.
We signed a globe, a joint venture with Sinopec and Enze fund in June which will accelerate the affordability and availability of green hydrogen in China to development of hydrogen generation projects, and increasing manufacturing capacity of electrolyzers and other key products in the green hydrogen supply chain.
As one of the largest hydrogen suppliers in China, Sinopec's annual hydrogen production reaches 3.5 million tons, accounting for 14% of total -- China's total hydrogen production.
China's embrace of green hydrogen is great for the planet, and Cummins and Sinopec joining together to realize the potential of green hydrogen is a huge leap forward for scaling our innovative PEM electrolyzer systems.
We recently announced a strategic collaboration with Chevron to develop commercially viable business opportunities in hydrogen and other alternative energy sources.
The MoU provides the framework for Chevron and Cummins to initially collaborate on four main objectives.
First, advancing public policy that promotes hydrojet -- hydrogen as a decarbonizing solution for transportation and industry; building market demand for commercial vehicles and industrial applications powered by hydrogen; developing infrastructure to support the use of hydrogen for industry and fuel cell vehicles; and fourth, exploring opportunities to leverage Cummins electrolyzer and fuel cell technologies at one or more of Chevron's domestic refineries.
The partnership with Chevron allows us to scale low carbon fuel delivery and build hydrogen corridors for use by fuel cell vehicles.
In addition, we can work with Chevron to decarbonize parts of their operations using our green hydrogen technology.
Finally, last week, Cummins announced the signing of an MoU with Air Products to work together to begin the transition of Air Products' heavy-duty tractor fleet to zero emissions vehicles in the Americas, Europe and Asia.
Cummins will provide hydrogen fuel cell electric powertrains integrated into selective -- selected OEM partners' heavy-duty trucks for use by Air Products.
The project will take a phased approach to transition Air Products fleet to hydrogen fuel cell electric powertrains, starting with five demonstration units to be delivered in Europe and North America by the end of next year.
Following successful demonstration, the project includes ramp-ups, which -- with a total of 2,000 trucks to be delivered by the middle of the decade.
This represents among the largest orders for fuel cell vehicles to-date, and we will be working with a partner that has deep expertise in the generation, transportation and use of hydrogen.
We've now deployed more than 2,000 fuel cells and 600 electrolyzers around the world as we continue the development of our hydrogen business.
In addition to accelerating our revenue momentum via these important strategic partnerships, we are also building out our electrolyzer capacity, targeting the regions which we expect to be at the forefront of green hydrogen production and commercial adoption.
Site selection search within the Guadalajara area of Castilla-La Mancha in Spain is currently underway for Cummins new approximately $60 million PEM electrolyzer manufacturing plant that will house system assembly and testing for approximately 500 megawatts per year of electrolyzer production and will be scalable to more than one gigawatt per year.
Cummins-Enze, the JV we signed in conjunction with Sinopec, will be located in Foshan, Guangdong province in China.
The JV will initially invest $47 million to locate a manufacturing plant to produce PEM electrolyzers.
The plant will open with a manufacturing capacity of 500 megawatts of electrolyzers per year, but will also be scalable to more than one gigawatt per year.
These investments, in addition to our build-outs underway at our current facilities in Belgium and Canada, will position us to have nearly two gigawatts of capacity by the middle of the decade with the flexibility to scale up as demand accelerates.
In the battery electric space, we continue to produce and sell fully electric powertrains in first-mover markets such as transit, school bus and yard spotters.
Cummins is collaborating with PepsiCo's Frito-Lay on a electric demonstration truck for a pickup and delivery application that has been running daily routes since last November.
This truck will be showcased at the upcoming North American Council for freight efficiencies electric truck demonstration.
We are well positioned with our deep market expertise in electric powertrain technology and are continuously evaluating how we can adapt and improve to meet customer demand and market trends as the technology matures.
This includes next-generation battery electric systems to balance the durability needs of our customers while focusing on delivering products at a compelling price point.
We are also continuing to explore new partnerships to enhance our capabilities, improve our cost position and drive more volume and scale into the business.
In addition to these important milestones for our New Power business, we are investing in our Engine and Components businesses to develop advanced diesel and alternative fuel products, which will be critical to meeting customer and regulatory requirements in the coming years.
We announced the signing of an LOI to acquire a 50% equity interest in Momentum Fuel Technologies.
The joint venture between Rush Enterprises and Cummins will produce Cummins-branded natural gas fuel delivery systems for the commercial vehicle market in North America, combining the strength of Momentum Fuel Technologies compressed natural gas fuel delivery systems Cummins powertrain expertise and the engineering and support infrastructure of both companies.
We have seen increasing interest over last year and expect natural gas powertrains to become an increasingly popular choice for end users due to both a compelling total cost of ownership as well as the environmental benefit of such powertrains, especially when utilizing renewable natural gas sources.
We also began testing of a hydrogen-fueled internal combustion engine for heavy-duty truck applications, building on Cummins' existing technology leadership in gases fuel applications and powertrain leadership to create a new power solution to help customers meet the energy environmental needs of the future.
The hydrogen engine program can potentially expand the technology options available to achieve a more sustainable transport sector complementing our capabilities in hydrogen fuel cell, battery electric and renewable gas powertrains.
We are committed to bringing customers the right solution at the right time.
Doing so requires us to maintain a broad portfolio of power solutions to meet our diverse customers' needs and to minimize total carbon emissions throughout the energy transition.
Now I'll comment on the overall company performance for the second quarter of 2021 and cover some of our key markets, starting with North America before moving on to our logos international markets.
Revenues for the second quarter of 2021 were $6.1 billion, an increase of 59% compared to the second quarter of 2020.
EBITDA was $974 million or 15.9% compared to $549 million or 14.3% a year ago.
EBITDA increased as a result of stronger global demand and higher joint venture income, partly offset by significantly higher premium freight and other costs associated with supply chain disruptions in addition to higher compensation costs.
Our global markets experienced an unprecedented shock from the impact of COVID-19 during the second quarter of last year.
And while we have been encouraged by the ongoing recovery across all of our global markets, our industry continues to experience significant constraints across the supply chain, leading to an extended period of inefficiencies and higher costs.
Despite these supply chain impacts, though, we are continuing to deliver strong financial performance while supporting our customers.
The ability to supply our customers remains our key focus now.
And while we are optimistic that the supply chain constraints will ease with time, they are likely to persist through the end of the year.
Our second quarter revenues in North America grew 74% to $3.5 billion, driven by higher industry build rates across all on-highway markets.
Industry production of heavy-duty trucks in the second quarter was 67,000 units, an increase of 180% from 2020 levels.
While our heavy-duty unit sales were $23,000, an increase of 217% from 2020.
Industry production of medium-duty trucks was 29,000 units in the second quarter of 2021, an increase of 94% from 2020 levels, while our unit sales were 22,000 units, an increase of 85% from 2020.
We shipped 42,000 engines to Stellantis for use in the Ram pickups in the second quarter of 2021, an increase of 272% from 2020 levels.
Revenues for Power Generation grew by 48% due to higher demand in recreational vehicle, standby power and data center markets.
Our international revenues increased by 42% in the second quarter of 2021 compared to a year ago.
Second quarter revenues in China, including joint ventures, were $2.1 billion, an increase of 8% due to higher sales in power generation and mining markets.
We also experienced a higher penetration rate with our joint venture partners in the heavy and medium-duty on-highway markets as they prepare for broader implementation of NS VI in July of this year.
Industry demand for medium and heavy-duty trucks in China was 566,000 units, a decrease of 4%, but still well above replacement, driven by continued pre-buy of NS V trucks, ahead of the broader implementation of the new NS VI standards in July of this year.
Our sales and units, including joint ventures, were 85,000 units, a decrease of 5% versus the second quarter of 2020.
The light-duty market in China decreased 8% from 2020 levels to 614,000 units, while our units sold, including joint ventures, were 38,000, a decrease of 28%, driven by supply chain constraints, particularly in these lighter displacement vehicles.
Industry demand for excavators in the second quarter was 97,000 units, a decrease of 5% from very high 2020 levels.
Our units sold were 16,800 units, a decrease of 7%.
The demand for power generation equipment in China increased 47% in the second quarter, driven by growth in data center markets and other standby power markets.
We continue to hold a leading market position in the data center segment, driven by strong end-user relationships and a compelling product offering in that space.
Second quarter revenues in India including joint ventures were $392 million, an increase of 219% from the second quarter of 2020, despite experiencing a terrible second wave of COVID-19 during this period.
Industry truck production increased by 468%, while our shipments increased 535%, as our joint venture partner continued to gain share.
Demand for power generation and construction equipment rebounded strongly in the second quarter, compared to a very low base a year ago.
We remain encouraged by the continued economic recovery, driven by anticipated government infrastructure spending.
In Brazil, our revenues increased 175%, driven by increased demand in most end markets.
Now let me quickly cover our outlook for 2021.
Based on our current forecast, we are maintaining full year 2021 revenue guidance of up 20% to 24% versus last year.
EBITDA is still expected to be in the range of 15.5% to 16%.
And the company expects to return 75% of operating cash flow to shareholders in 2021, in the form of dividend and share repurchases.
And summing up the quarter, strong demand across many of our key markets drove continued sales growth in the second quarter and resulted in solid profitability.
We have secured important new partnerships in our New Power segment.
At the same time, we continue to invest in bringing new technologies to customers, outgrowing our end markets and providing strong cash returns to our shareholders.
Cummins Filtration is a premier filtration platform and a technology leader specializing in filtration products used in heavy-medium-duty and light-duty trucks, industrial equipment and power generation systems.
The business generated revenues of approximately $1.2 billion in 2020, and remains well positioned for continued growth, sustained margin performance and strong free cash flow generation.
Cummins Filtration has a strong global footprint with leading positions in North America, India and China.
And a significant presence in other key markets supported by long-standing local partnerships.
We are exploring a range of options to unlock significant shareholder value, including the separation of Filtration into a stand-alone company with a dedicated management team, who are well positioned to drive the business forward and diversify its business, leveraging strong technology portfolio and footprint.
The execution of this exploration process is dependent upon business and market conditions, of course, along with a number of other factors and considerations.
And any costs associated with the evaluation of these alternatives for the Filtration business has been excluded from our financial outlook.
We plan to share a lot more about this and other elements of our strategy, during our Analyst Day on February 23rd.
Our purpose in delaying this event from November this year, until spring, is to be able to hold it in person.
And we will provide more details as we get closer, to the February 23rd date.
There are four key takeaways from our second quarter operating results.
First, underlying demand remains strong, outpacing supply and increasing backlogs in some of our largest markets.
Number two, global supply chains remain constrained due to the elevated levels of demand and complications arising from COVID, resulting in higher premium freight costs and other associated inefficiencies than we anticipated three months ago.
We delivered solid profitability and cash flows in the first half of the year despite the continued cost headwinds associated with tight supply chain.
And for the full year, we are maintaining our revenue and profitability guidance.
And fourthly, we returned $860 million to shareholders in the quarter through cash dividends and share repurchases and $1.48 billion for the first half of the year, consistent with our plan to return 75% of operating cash flow to shareholders this year.
Now let me go into more details on the second quarter.
Second quarter revenues were $6.1 billion, an increase of 59% from a year ago when the impact of COVID-19 was at its most severe.
Sales in North America grew 74% and international revenues rose 42%.
Currency positively impacted revenues by 3%, driven primarily by a weaker US dollar.
EBITDA was $974 million or 15.9% of sales for the quarter compared to $549 million or 14.3% of sales a year ago.
EBITDA increased primarily due to the benefits of higher volumes and stronger earnings from our joint ventures in China and India, partially offset by higher product coverage costs and higher compensation expenses primarily variable compensation.
Gross margin of $1.5 billion or 24.2% of sales increased by $588 million or 110 basis points, primarily driven by the higher volumes, global supply chain tightness continued in the second quarter and resulted in approximately $100 million of additional freight, labor and logistics costs.
We expect these costs to remain elevated in the second half of the year with demand projected to remain strong, supply tight and some increase in logistics and transportation costs.
Selling, general and administrative expenses increased by $130 million or 28% due to higher compensation expenses.
And research expenses increased by $87 million or 46% from a year ago.
As a reminder, due to the significant uncertainty at the onset of COVID-19, we implemented temporary salary reductions in April of last year that lasted through the end of September last year.
Salary reductions resulted in approximately $75 million of pre-tax savings for the company in the second quarter of 2020 across gross margin, selling, admin and research expenses.
In addition, our variable compensation plan worked as designed, flexing down in the face of weaker economic conditions last year and flexing up with stronger financial performance this year.
All operating segments experienced higher compensation costs than a year ago for these two primary reasons.
Joint venture income was $137 million in the second quarter, up from $115 million a year ago.
Strong demand for trucks and construction equipment in China as well as a broad recovery in other international markets led to the improved profitability versus a year ago.
Other income increased by $30 million from a year ago due to a number of positive items, including a one-time $18 million gain on the sale of some land in India, which benefited our Distribution segment.
Net earnings for the quarter were $600 million or $4.10 per diluted share compared to $276 million or $1.86 from a year ago, primarily due to stronger after-tax earnings driven by stronger volumes.
The gain on the sale of land in India contributed $0.05 of earnings per share this quarter.
The effective tax rate in the quarter was 21.4%.
Operating cash flow in the quarter was an inflow of $616 million, compared to an outflow of $22 million a year ago.
Stronger earnings and dividends received from joint ventures more than offset increases in working capital.
I'll now comment on segment performance and our guidance for 2021, which is unchanged from three months ago.
For the Engine segment, second quarter revenues increased by 75%, driven by increased demand for trucks in the U.S. and construction equipment in U.S. and Europe.
EBITDA increased from 10.5% to 16.1% of sales, primarily driven by higher volumes and lower product coverage expense, which more than offset higher costs and inefficiencies associated with global supply chain challenges.
And although, supply chain costs in this segment remain elevated from a year ago, they did improve a little from first quarter levels.
We expect full year revenues to be up 23% to 27%, and EBITDA margins to be in the range of 14.5% to 15% for the Engine segment.
In Distribution, revenues increased 20% from a year ago.
And EBITDA increased as a percent of sales from 10% to 10.5%, primarily due to stronger performance in North America.
We have maintained our outlook for segment revenue growth to be up 6% to 10%, and EBITDA margins to be 9% at the midpoint of our guidance.
In the Components business, revenues increased 73% in the second quarter, driven primarily by stronger demand for trucks in North America.
EBITDA increased from 12.3% of sales to 15.1%, due to the benefits of stronger volumes, partially offset by higher product coverage costs.
For the full year 2021, we expect Components revenue to increase 30% to 34% and EBITDA to be 17%, at the midpoint.
In the Power Systems segment, revenues increased 47% in the second quarter, driven by stronger global demand for power generation and mining equipment.
EBITDA increased from 11.7% to 12.2% of sales, primarily due to the benefits of higher volumes and lower product coverage expenses.
We are maintaining our Power Systems guidance of revenues up 16% to 20%, and EBITDA margin in the range of 11% to 11.5% of sales.
In the New Power segment, revenues increased to $24 million, up 140%, due to stronger sales of battery electric systems and fuel cells.
EBITDA losses for the quarter were $60 million, in line with our expectations, as we continue to invest in new products and scale up ahead of widespread adoption of the new technologies.
For Full year, we currently project New Power revenues of $110 million to $130 million and EBITDA losses to be in the range of $190 million to $210 million.
Total company guidance remains unchanged, with revenues to grow between 20% and 24%.
And EBITDA margin to be between 15.5% and 16%, for the full year.
EBITDA perfect for the first half of the year was 16%.
Some of the key factors expected to influence second half profitability, are the piece of improvement in truck production in North America, the rate of decline in demand in China, and the performance of the global supply chain.
We now expect earnings from joint ventures to be up 10% in 2021, compared to our prior year guidance of down 5%.
Stronger-than-expected demand in China truck and construction markets, especially in the second quarter, is the primary reason for the increase in our forecast.
So joint venture earnings are expected to ease in the second half of the year with industry truck sales expected to decline following the broader adoption of the new National Standard VI on highway emissions regulations in China in July.
And we also anticipate a softening of demand for construction equipment coming off all-time high levels in the first half of the year.
Our effective tax rate is expected to be approximately 21.5%, excluding discrete items, down from our prior guidance of 22.5% due to the mix of geographic earnings, capex -- capital expenditures were $125 million in the quarter, up from $77 million a year ago.
And we expect our full year capital expenditures to be at the high end of our range of $725 million to $775 million for the full year.
We returned $869 million to shareholders through dividends and share repurchases in the second quarter, bringing our total cash returns to $1.48 billion for the first half -- excuse me for my dry throat.
To summarize, we delivered strong results in the second quarter despite continued supply chain constraints and elevated costs.
Demand currently exceeds supply in a number of important markets, pointing to strong demand for our products into 2022.
We continue to extend our leadership position through advancing the technologies that power the profitability of our customers today and will continue to do so for some time to come.
This sets the company up to further increase the earnings power of our core business while we continue to invest in a range of new technologies and develop new partnerships that position the company for additional growth.
Our strong balance sheet focused on improving performance cycle-over-cycle and consistent cash flow generation means that we can sustain important investments for the future through periods of economic uncertainty and distribute excess cash to shareholders.
Out of consideration to others on the call, I would ask that you limit yourself to one question and a related follow-up.
And if you have additional questions, please rejoin the queue.
Operator, we are now ready for our first question.
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q2 earnings per share $4.10.
q2 revenue $6.1 billion versus refinitiv ibes estimate of $6 billion.
sees fy revenue up 20 to 24 percent.
also announcing exploration of strategic alternatives for its filtration business.
potential strategic alternatives to be explored include separation of cummins filtration business unit into a stand-alone company.
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Joining in for the Q&A session are Brad Griffith, our Chief Commercial Officer; as well as George Schuller, our Chief Operations Officer.
Before we get started, I'll remind everyone that the remarks we make today represent our view of our financial and operational outlook as of today's date, November 5, 2020.
These expectations involve risks and uncertainties that could cause the company's actual results to differ materially.
A discussion of these risks can be found in our SEC filings located online at investors.compassminerals.com.
Our remarks today also include non-GAAP financial measures such as adjusted EBITDA and free cash flow.
There are several reasons for that delta, primarily related to delayed ordering of Plant Nutrition products in our North and South American markets.
Those timing issues were driven by very dry weather in both Brazil and key North American markets, as well as extreme wildfires in the western part of United States.
We also reported an unfavorable non-cash inventory adjustment related to an error in bulk stockpile measurements at our Ogden, Utah, SOP facility, which Jamie will discuss in more detail shortly.
Because we expect these third quarter market disruptions to be short-term, I'll focus my remarks instead on our year-to-date performance.
On a consolidated basis, operating earnings for the year-to-date period increased 19% and EBITDA rose 10% compared to 2019 results.
In addition, we generated over $188 million of cash flow from operations, which is a 93% increase from 2019.
These are very strong results given the fact that we experienced a mild winter and all of our deicing markets in the first quarter as well as the operational challenges stemming from the global pandemic beginning in March.
As many of you have heard me say before, our number one priority as a management team is ensuring our employees go home at the end of their shift as healthy as when they arrived.
Our focus on this Zero Harm culture has been as critical to our ability to navigate the current pandemic as it is toward the sustainability of our organization.
And anyone who has spent their career in mining knows the value of this focus, benefits all stakeholders, as it has been proven time and time again that over the long-term, the safest operations are also the most productive operations.
This quarter, we continued to see a decline in our total case incident rate or TCIR, in addition to achieving a multi-year low for our 12-month rolling TCIR average.
I'm very happy to share that our TCIR in September was among the lowest of any month in the history of the company.
I would also like to specifically commend the employees at our Ogden facility for their exemplary safety performance.
They're very near to achieving 1 million exposure hours with no lost time safety incidents.
As a leading indicator for operational success, this continuous improvement in our safety metrics speaks volumes about the discipline and commitment to safe and responsible operations our employees bring to their jobs each and every day.
I may sound like a broken record here, but it's a song I'm really glad to sing.
Our Goderich mine continued to deliver very strong year-over-year production results.
For the quarter, production volumes were 53% ahead of third quarter 2019 results, while the cost to produce these tons declined 24%.
On a year-to-date basis, production tons have increased 28% from 2019 levels and production costs are down 11%.
These steadily improving metrics highlight the strength of our continuous mining platform there, which will help to ultimately secure Goderich's position as the leading salt mine in North America from both the cost and volume perspective as we continue to build our new mine plan there over the long-term.
Our Cote Blanche mine has also demonstrated strong performance year-to-date.
Not to mention, an impressive dose of moxie, by meeting the challenges posed by not one but four significant hurricane events in 2020.
These storms resulted in seven lost production days during the third quarter and another four lost production days in October.
The preparations made by our team to protect the site and the safety of our people meant we've been able to resume production efficiently and effectively after each event.
As another testament to our operational agility, we expect to make up most if not all the lost production from those unplanned outage days by the end of the year.
This quarter, the Salt segment also delivered early benefits from our enterprisewide optimization effort, particularly in terms of lower logistics costs.
Our logistics team has worked diligently to reshape our network of partners to maximize efficiencies across our operations to deliver cost savings, while maintaining strong service levels for our customers.
Keep in mind that we typically move more than 12 million tons of bulk materials using multiple transportation modalities each year.
Their work has helped to offset the impact of some of the short-term freight rate inflation, we are experiencing this year.
Our commercial teams have also been highly engaged in the enterprisewide optimization effort, looking for opportunities to adjust and improve customer mix as well as pricing levels.
These efforts were largely responsible for the 8% year-over-year increase achieved for consumer and industrial average selling prices this quarter.
These achievements were important drivers for the margin expansion we've reported that helped us overcome the impact of lower sales volumes due to mild winter weather so far in 2020, as well as the COVID-19 impacts on non-deicing salt sales.
Before moving on, I'd like to provide a final update on the 2020-2021 North American highway deicing bid season.
Given the mild weather during last winter, it came as no surprise that the bid season was competitive, as we noted in our second quarter call, with total bid tenders down roughly 15%.
We've essentially completed all bidding activity and have achieved 4% growth in our contracted bid volumes with a price decline of 11% compared to prior bid season results.
Consequently, these bid season results along with slightly elevated customer inventories had us trailing our full year salt volume guidance by about 250,000 tons for 2020.
Ultimately, our deicing salt sales are driven by winter weather, and we expect the production and logistics cost improvements we've made provide offsets to lower bid season prices.
Similar to the hurricanes hitting Louisiana, our Plant Nutrition business, particularly in North America, faced some unforeseen circumstances this past quarter, including extreme wildfires and drought.
The spoke from these events has delayed the harvest of key crops, particularly tree nuts.
This has also delayed the fall fertilizer application season and thus, we believe that a portion of expected third quarter 2020 sales volumes have been pushed into the fourth quarter.
Recent conversations with customers have reinforced our confidence that underlying demand remains robust for the remainder of 2020, particularly given that some of these harvests are expected to be very strong translating into nutrient deficiencies for the soil and thus the need for our products.
Similarly in Brazil, we experienced some timing issues with sales volumes in the third quarter.
After a very strong second quarter, we believe some of our agriculture product sales were accelerated.
Additionally, the hot and dry weather in that geography has also been unfavorable.
So we believe a portion of what we expected to sell in the third quarter has now shifted into the fourth quarter.
On a positive note, South American farmer economics continue to be very attractive, particularly for soybeans.
In fact, a record level of the soy crop in Brazil has already been forward sold, which means farmers need yield and thus will need our specialty plant nutrients to support that yield.
As a result of these underlying positive market fundamentals in Brazil and North America, we're keeping our sales volume ranges for 2020 unchanged for both the Plant Nutrition North and South America segments.
Against the backdrop of the challenges we've all faced in 2020, I'm even more impressed with the efforts of our employees to engage and execute on our enterprisewide optimization effort.
This effort is focused on five broad value streams namely; operations, commercial, logistics, procurement and working capital.
I referenced previously in my comments some of the early benefits coming through our Salt segment results from certain of these value streams.
We also highlighted last quarter the progress we're making with engaging our employees through our organizational health focus, as well as a compaction project at Goderich mine to essentially recycle salt fine waste into salable product at a minimal incremental cost.
Today, I'd like to share a little detail regarding a very exciting project at our Ogden, Utah facility.
As many of you know, our solar evaporation pond-based SOP production at this site is among the lowest cost processes globally for the specialty form of potassium.
Anything we can do to expand our ability to produce with that low-cost feedstock further increases our competitive advantage domestically and globally.
In a typical year, the very convinced brines from which we extract both salt and SOP feedstock has been two months in the final evaporation stage.
After draining those ponds, we then spent 10 months harvesting, which is essentially scooping up the material from dry pond beds and transporting the material to the production plant.
The goal of our optimization project is to extend the evaporation season and decrease the length of the harvest period.
Doing so is expected to materially increase the yield of feedstock from the ponds, by insourcing our harvest and haul activities using pond-appropriate equipment, we can do just that.
The change in equipment allows us to work faster and deliver more tons per load of material to our Salt and SOP plant.
Currently, under this new equipment setup, we're delivering 28% more tons per load for SOP and about 14% more for salt.
As a result, we're able to shorten our harvest season to eight months and extend our evaporation season to four months, which ultimately provides us with more and higher quality SOP feedstock.
Further this new equipment is expected to be safer for our ponds, further reinforcing our sustainable harvest practices.
This project highlights our ability to look at old problems and generate new and innovative solutions to help ensure the long-term sustainability and growth of our company.
As we continue to execute on the many projects throughout these value streams, over the next couple of years, we expect to fundamentally improve the earnings potential of Compass Minerals.
In the near-term, we continue to aggressively work to overcome the various external factors, which have reduced our earnings compared to our original outlook for 2020.
Just to level set a bit, we entered the year with a strong expectation for around 20% EBITDA growth using the midpoint of our guidance provided in February.
We now estimate a combined negative impact of this original forecast of about $45 million from several factors, which were largely outside of our control.
These include mild winter weather in the first quarter, a Brazilian currency that progressively weakened throughout the year and COVID-19 impacts, including both the cost of preventative measures at our sites and demand impacts on certain customer and industrial products.
Despite these external challenges, through a laser focus on cost and buttressed by our improved operational performance, we still expect to deliver EBITDA growth for the full year and additional growth in 2021.
This is possible because of the underlying resilience of the markets we serve with our essential products, the strength of our advantaged assets and the dedication of our employees to drive improvements through our optimization effort.
We've also stayed on course with our strategic priorities and maintained close contact with our customers throughout these unprecedented times.
I've recently had the chance to talk with a number of them personally, about their own challenges in growth opportunities and through their perspective, have an even greater appreciation for the essential nature of our products and the important role we serve for our customers as well as the communities where we operate.
All of these things generate great excitement for me and the entire Compass team.
Now let's hear from Jamie who will discuss the third quarter results and outlook in more detail.
I'll start on Slide 9 with some comments on our consolidated results, which were challenged by several factors as Kevin discussed.
First, sales volumes were lower in each of our segments versus the third quarter of 2019.
However, we're actually performing quite well on a year-to-date basis, due to a number of timing issues across all three segments which pulled sales into the first half of 2020.
Salt segment sales volumes are down just 9% on a year-to-date basis, which is more than explained by the weak winter weather we experienced during the first quarter of 2020.
As a reminder, first quarter 2020 snow events were 24% below the 10-year average and 30% below 2019 levels.
This weak weather caused customers to take their minimums in the second quarter and therefore put pressure on our third quarter early fill orders.
On a year-to-date basis, Plant Nutrition North America sales volumes are up 20% versus the 2019 period, which you may recall with very challenging due to the excessive rainfall in our served markets.
Our Plant Nutrition South America segment generated a 5% year-over-year increase in sales volume on a year-to-date basis as strong and early demand for plant nutrients in the first half of the year offset third quarter sluggishness.
Our third quarter Salt operating results helped offset the lower year-over-year third quarter operating earnings and EBITDA results in both of our Plant Nutrition businesses.
Lower year-over-year third quarter sales volumes in both Plant Nutrition segments and an inventory adjustment charge in the Plant Nutrition North America segment were the primary drivers of the decline.
Despite the challenges we faced, we delivered double-digit consolidated earnings growth as well as strong free cash flow of $126 million through the first nine months of 2020.
We discuss our Salt segment third quarter 2020 results on slide 10.
Third quarter revenue declined 11% compared to the prior year on a 13% drop in sales volume, slightly offset by a 1% increase in average selling prices.
Volumes declined for both our highway deicing and consumer and industrial sales.
In addition to lower year-over-year pre-season demand for deicing products, we are still experiencing some slack in demand for other consumer and industrial products due to COVID-19 challenges.
Average salt selling prices in the third quarter of 2020 increased 1% compared to third quarter 2019 results.
A shift in sales mix toward lower price chemical sales pushed highway deicing pricing down 8%, while consumer and industrial average selling prices increased 8%, largely due to strategic price increases implemented as a result of our enterprisewide optimization effort.
On a net price basis, we actually achieved a 5% improvement in average selling price versus third quarter 2019 results, with highway deicing average net price flat to prior year results and consumer and industrial net price up 8%.
Improved production and logistics costs in the 2020 third quarter more than offset lower revenue and resulted in year-over-year increases of 21% for operating earnings and 17% for adjusted EBITDA.
In addition to improved Goderich production, we have aggressively implemented initiatives across logistics and procurement that are driving our costs lower.
Beyond the logistics improvements Kevin mentioned, we have rationalized our spending patterns to reduce waste.
We've also upgraded our global sourcing efforts with comprehensive negotiation of agreements with key contractors and optimization of raw material pricing across all businesses to achieve more favorable scale.
These efforts contributed to the expansion of the Salt segment EBITDA margins of 30% compared to 23% in the third quarter of 2019.
While these initiatives are expected to drive sustainable improvements for all segments over time, we're pleased to see these early benefits in our Salt results.
Turning to our Plant Nutrition North America results, which we discuss on Slide 11.
We reported a 21% year-over-year decline in revenue on a 22% decline in sales volumes and a 2% higher average selling prices.
As already noted, the extreme wildfire conditions in the Western US have delayed the start of the application season and we believe they have shifted the timing of SOP sales for the fourth quarter this year.
Earnings for this segment were further reduced by an inventory adjustment due to an error we identified in our measurement of our bulk stockpiles with standard SOP at our Ogden, Utah facility.
This is the product that we stockpile and then process through our compaction system into the various high value grades of SOP that our customers demand.
While we regularly estimate the size of our stockpiles, this can be difficult to assess due to the size and limited accessibility of our storage domes in silos.
As we depleted our standard SOP inventory, we detected a stockpile shortfall which occurred over a period of time, as these particular domes had not been zeroed out or fully emptied for several years.
Once we identified the issue, we reviewed our processes and are implementing several additional operational control enhancements that will improve our estimates going forward and prevent this from occurring in the future.
It is important to note that we have determined that this inventory adjustment is not material to any single prior period, and furthermore, this adjustment has no impact on our 2020 free cash flow, and we don't expect these operational enhancements to impact our ability to serve our customer demand or the future profitability of the Plant Nutrition North America segment.
We discuss our Plant Nutrition South America segment results on Slide 12.
This segment delivered a 5% year-over-year increase in third quarter 2020 revenue in local currency, driven by increases in average selling prices for both agriculture products and chemical solutions products.
These price improvements offset a year-over-year decline in agriculture and chemical solutions sales volumes.
As we noted on our second quarter earnings call, demand came early for many of our specialty Plant Nutrition products due to a very attractive grower economics for the Brazilian farmer.
Therefore, some of that pull forward in Q2 is showing up as weakness here in the third quarter.
However, we continue to see strong third quarter year-over-year revenue growth in our direct-to-grower sales channel on flat volumes and improved product sales mix.
Both direct-to-grower and B2B sales volumes were also impacted by the late start of the spring rains in the Cerrado region in the Central of Brazil.
These dry conditions delayed fertilizer applications and we believe they are therefore pushing some of our sales volumes into the fourth quarter.
In local currency, third quarter 2020 operating earnings and EBITDA declined 9% and 7% respectively, which was mostly attributable to lower volumes in our B2B business compared to the prior year quarter and continued aggressive investment in our direct-to-grower sales force.
We discuss our outlook for our segments on Slide 13.
While we have reduced our full year Salt sales volume guidance, we still expect an increase in our Salt sales volumes and revenue in the fourth quarter compared to prior year.
Our EBITDA margin for this business is expected to contract, due to the reduction in average awarded bid prices for our North American highway deicing customers.
Ultimately, our average reported highway deicing sales price will be impacted by the sales mix we achieved in the quarter based on winter weather activity.
In an average winter scenario, we're expecting highway deicing average selling prices to decline about 8% compared to prior year and the Salt segment overall is expected to see a price decline of around 5%.
We continue working to offset the impact on our operating margins with both value creation and cost containment through our enterprisewide optimization effort.
We expect improved sales demand sequentially and year-over-year for both of our Plant Nutrition businesses.
In North America, our sales and earnings are expected to be driven by a rebound in SOP sales to Western US markets that have been negatively impacted by wildfires and dry conditions.
The fourth quarter is also typically the strongest selling season for micronutrients.
And that seasonality should drive modest improvements in sequential price results.
In Brazil, given the fact that so many soybean growers forward sold their crops, achieving strong yields will be important and we anticipate a strong rebound in sales volumes in the fourth quarter.
Additionally, the spring rains in many of these important growing regions is now well under way which bodes well for our fourth quarter results.
Although we expect increases in sales volumes compared to 2019 fourth quarter results, the weaker currency is expected to keep our reported US GAAP results flat with prior year.
In local currency, however, we expect to deliver 20% to 25% EBITDA growth compared to prior year.
Full year outlook items are found on Slide 14.
Due primarily to the modest reduction in our full year salt sales volumes, weaker Brazilian currency and the ongoing COVID-19 operational and commercial impacts, we have decided to update our full-year adjusted EBITDA guidance.
Excluding the inventory adjustment, we are now expecting to deliver $330 million to $345 million of adjusted EBITDA for the full year 2020.
Now finishing up on Slide 15.
We are very pleased to report that we still expect strong free cash flow generation of around $125 million for the full year despite the headwinds Kevin and I have discussed today.
Our net debt to adjusted EBITDA ratio is expected to end the year below 4 times as we continue to make progress improving our balance sheet and maintaining a very strong liquidity position.
As we enter these last two critical months of 2020, we remain focused on keeping our people safe, controlling our costs, optimizing our operations and delivering our essential products to satisfied customers around the world.
With that, I will ask the operator to begin the Q&A session.
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full-year 2020 adjusted ebitda outlook of $330 million to $345 million.
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Today, we will discuss our recent results and our outlook for 2021.
Joining in for the Q&A session are Brad Griffith, our Chief Commercial Officer, as well as George Schuller, our Chief Operations Officer.
Before getting started, I would remind everyone that the remarks we make today represent our view of our financial and operational outlook as of today's date, February 17, 2021.
These expectations involve risks and uncertainties that could cause the company's actual results to differ materially.
A discussion of these risks can be found in our SEC filings located online at investors.compassminerals.com.
Our remarks today also include certain non-GAAP financial measures.
I'll start today by giving a top-line overview of our financial and operating results for 2020 before providing some thoughts on the impacts of our enterprisewide optimization efforts, as well as our path forward.
As we look back on the year from a broader perspective, 2020 introduced personal and professional challenges to each and every one of us.
I'm incredibly grateful to the men and women of our company for staying laser-focused on operating safely and responsibly, continuing to bring forward new ideas for improvement and remaining committed to delivering for our customers, communities and our shareholders during this extremely difficult time.
We'll provide more color on those shortly.
We're taking steps internally to further girth our preparedness for such events.
That said, I continue to believe strongly that our team's prudent management and unwavering commitment to our enterprisewide optimization efforts underpinned longer term transformational benefits that we started to see throughout our operations, and fully expect to positively impact our financial results in the future.
One key factor we simply cannot control, but rather we must manage through, is the weather.
We estimate the weak winter weather season in both the first quarter and fourth quarter of last year negatively impacted our full-year 2020 operating income by approximately $40 million to $45 million.
Other external factors adversely affecting our business during the calendar year included the wildfires in California and drought conditions in South America, both of which impacted demand timing from our Plant Nutrition customers and multiple hurricanes in the Gulf Coast, which required multiple brief but unplanned shutdowns at our Cote Blanche mines.
In addition, our South American Plant Nutrition business experienced stronger year-over-year agriculture sales volumes and, in local currency, achieved a 16% increase in fourth quarter operating earnings versus 2019.
However, the Brazilian currency weakened by approximately 33% during the year compared to the U.S. dollar, which ultimately hurt our bottom-line in terms of U.S. results.
As we look at full year 2020 on a consolidated basis, net income for the year decreased by approximately 5% and adjusted EBITDA decreased by approximately 8% when compared to 2019 results.
On the positive side, we continue to generate strong positive cash flow from operations totaling over $175 million for the full year.
We also took an aggressive approach to managing our capital plan and I'm pleased we were able to come in 13% below the midpoint of our original guidance for a total spend of roughly $85 million for the year.
Our free cash flow for the full year was just over $90 million and we returned at $99 million to shareholders through our dividend program, which reflects our confidence in the company's ability to deliver cash flow through varying economic and weather-related cycles.
As a result, we formally relaunched what is designed to be a targeted and expedient process for the sale of both of our Chemical and Plant Nutrition businesses in South America.
We intend to use the proceeds from these transactions to continue reducing our debt, further enhance our liquidity and continue our focus on meeting our customer demand for our essential products.
Given the sensitive nature of these matters, we will not be fielding any questions on this topic, but we'll provide more information as it becomes appropriate to do so.
With our multi-year runway of ample liquidity, no material debt maturities due for over three years, capital plan flexibility and improving execution capabilities, our near-term priority is to deploy any incremental free cash flow after dividends, whether from organic generation or strategic transactions, toward continuing our deleveraging process and paying down our debt to further enhance our equity valuation.
Now moving to our Salt segment.
Full-year adjusted EBITDA margins increased approximately 3 percentage points to 29% despite our adjusted EBITDA being lower by 2%.
We also saw continued improved production performance at our flagship Goderich mine.
On a full year basis, production tons out of Goderich have increased 17% from 2019 results and production costs are down 16%.
In addition, during the fourth quarter of 2020, the team was able to achieve its highest production month since its conversion to continuous mining and haulage.
These steadily improving production metrics highlight a sentiment you've heard me communicate before that we've not yet reached our full long-term potential at this operating assets.
I am confident our progress will continue as we build out our new mine plan, helping to ultimately secure Goderich's position as the leading salt mine in North America from both a cost and volume perspective.
When coupled with enhancements that are designed to provide long-term flexibility and optionality to our logistics and procurement teams, we set a course to capture significant value during stronger seasonal demand by meeting the needs of current and new customers alike.
Our Cote Blanche mine also demonstrated strong year-over-year operating performance, while managing through four significant hurricane events in 2020.
These storms resulted in approximately 11 lost production days during the year.
The preparations made by our team to protect the site and ensure the safety of our people allowed us to resume production efficiently and effectively after each event.
This culture of resilience that permeated throughout the organization in 2020 is perhaps best reflected in the operational agility of our Cote Blanche team who were still able to achieve their full year-end production targets, despite having navigated a record hurricane year in the Gulf.
In addition, given the recent announcement of a nearby competitor closing its facility, we are carefully analyzing opportunities to capture value for our portfolio by enhancing relationships with our existing customers, while also potentially putting us in a position to cultivate some new relationships.
I'd also like to give a particular call out to our logistics team, which has worked diligently on reshaping our network of partners to maximize efficiencies across our operations, while maintaining strong service levels for our customers.
As I mentioned previously, our Plant Nutrition business, particularly in North America, faced some unforeseen circumstances of its own this past year, including extreme wildfires and drought.
The resulting conditions from those events delayed the harvest of key crops, particularly tree nuts along with the fall fertilizer application season.
Our team worked to ensure we were well-positioned to capture those sales volumes in the fourth quarter, ultimately, delivering strong year-over-year revenue growth of 16%.
Given this strength, we were able to partially offset some of the unexpected higher costs that we experienced during the year.
Our Potassium+ product continues to be the SOP market share leader in North America and recent pricing dynamics have reinforced our confidence that near term underlying demand remains robust.
We anticipate upcoming harvest in certain key markets to be very strong, which further translates into nutrient deficiencies for the soil and the need for our products.
When coupled with much more positive global backdrop for all fertilizers and the recent surge in pricing, we anticipate steady demand from our North American customers in 2021.
I would also like to point out that our micronutrients products line was able to achieve a full-year gross sales record in 2020 since their acquisition.
Our South American Plant Nutrition business continued to achieve measured growth in local currency, with sales revenue up 18% for the full year 2020.
Our customers on the agricultural side have experienced very attractive fundamentals and we anticipate these sales trends to continue in 2021.
But as has been a recurring theme, the weaker currency has hurt our results in U.S. dollar terms.
Against the backdrop of the challenges we've all faced in 2020, I'm even more impressed with the efforts of our employees to engage and execute on our enterprisewide optimization effort.
As a reminder, this effort is focused on five broad value streams, namely; operations, commercial, logistics, procurement and working capital.
I referenced previously, in my comments, some of the early benefits coming through our Salt segment results from certain of these value streams.
In prior quarters, we highlighted our harvest haul project at our Ogden facility in Utah, the salt mines compaction project at Goderich and the progress we're making with employee engagement through our organizational health focus.
I would now like to highlight some optimization benefits we're experiencing in procurement.
In 2020, we completely transformed that department, moving from a decentralized and transactional function to a centralized high-standard team focused on operations excellence through global strategic sourcing mindset and a performance-driven culture.
We implemented a category management function, a team concept built to bring together procurement with all relevant areas within that segment.
Each team in a category is a cross-functional and cross-regional aligned to business needs and extensive engagement with stakeholders.
During its initial year in this new structure, the department executed over 65 initiatives, driving as much as 10% annualized savings in a number of specific procurement categories such as contractor services, packaging raw materials and equipment spare parts.
In addition to cost savings, this new procurement strategy is expected to reduce the risk of supply chain disruption and provide a market advantage when our customers require a more sustainable and responsible supply chain.
This high degree of focus from our team is expected to produce long lasting benefits and help expand our margins.
As we worked to both navigate external challenges and drive internal improvements over the course of 2020, there was no area of focus given more attention than our responsibility to keep our employees safe and healthy.
As many of you have heard me communicate before, our number one priority as a management team is ensuring our employees go home at the end of their shift as healthy as they arrived.
Our focus on this Zero Harm culture has been critical in our ability to navigate the current pandemic.
For the year, we achieved another step change decline in our Total Case Incident Rate or TCIR.
In addition to achieving a multi-year low for our 12 months rolling TCIR average in 2020, we ended the year with an average of 1.53 and I'm happy to share that our TCIR in December was among the lowest of any month in the history of the company, coming in at 1.23.
As a leading indicator for operational success, this continuous improvement in our primary safety metric highlights our commitment to conducting business in a responsible manner that protects the health, safety and security of all of our employees, contractors and the communities in which we operate.
The COVID-19 pandemic remains an ongoing challenge and we continue to take actions to mitigate its impacts.
In addition, we faced another slow start to the winter season in our served markets.
Yet our talented workforce, advantaged assets and efficient procurement and logistics operations continue to perform with excellence through this adversity, supporting our global customers with essential products proving our resilience as an organization.
While our overall financial performance in 2020 was below our expectations, we were aggressive in our efforts to mitigate the various external headwinds we faced.
We now estimate a combined negative impact to our original operating earnings forecast of roughly $67 million due specifically to weak winter weather in both the first and fourth quarters, a Brazilian currency that progressively weakened throughout the year and COVID-19 impacts, including both cost preventative measures at our sites and reduced demand within certain higher-margin end markets.
While these factors were out of our control, be assured, we are acutely focused on identifying steps we can take to help insulate our businesses from the severity of similar impacts in the future.
Again, what has allowed us to effectively navigate through the past year is the underlying resilience of the markets in which we serve with our essential products, the strength of our advantaged assets and the dedication of our employees to drive improvements through the optimization effort.
We've also maintained close contact with our customers and remained on course with our previously communicated strategic priorities.
I continue to be excited about the future prospects of our company and confident of long-term value our team, at Compass Minerals, can deliver.
First, a quick review of our consolidated results.
Our fourth quarter 2020 consolidated sales revenue and operating income, both declined year-over-year as late winter weather coupled with lower highway deicing average gross sales price pressured Salt results.
Lower year-over-year SOP pricing, along with elevated SOP production costs more than offset Plant Nutrition North America sales volumes improvements.
For the full year, sales revenue and operating income were also lower as we dealt with over $100 million in sales revenue impact and more than $40 million of operating earnings and tax due to weak winter weather.
We also had elevated SOP costs and lower SOP pricing, which were partially offset by stronger year-over-year SOP sales volumes.
Looking now at our Salt segment results.
Total sales in the quarter were $228.5 million, down from $310.9 million in the fourth quarter of 2019, largely due to lower weather-driven demand for deicing products and the effects of customer carryover inventories.
Although the snow event activity was similar to last year's December quarter, this year's winter had been slow to develop with most of the fourth quarter snow events occurring at the tail end of December.
This winter weather impact, combined with high customer inventory levels, resulted in lower deicing salt sales to highway, commercial and big-box retailers.
Total Salt segment sales volumes dropped to 23% compared to fourth quarter of 2019.
Within our Salt segment, highway deicing experienced a 25% sales volume decline and consumer and industrial sales volumes dropped 16% year-over-year.
Looking at our sales by end-use, rather than by business unit, most of the volume weakness was attributable to lower deicing demand.
In other words, combined sales of most of our non-deicing products, such as water conditioning, chemical processing and food and agriculture were not impacted by the weather and were generally flat with the prior year fourth quarter, even after taking into account some lingering slack in demand due primarily to COVID-19 challenges.
Highway deicing prices were down 11% versus the prior year quarter at $59.20 per ton.
However, consumer and industrial average selling prices increased 1% to $169.30 per ton as a broad-based price increases across all non-deicing product groups was mostly offset by lower sales mix of our higher priced deicing products.
Operating earnings for the Salt segment totaled $50.2 million for the fourth quarter versus $80.5 million last year, while EBITDA for the Salt segment totaled $67.6 million compared to $96.5 million in the prior year quarter.
Despite the challenging environment I just described, we are pleased to report minimal EBITDA margin compression in our Salt segment this quarter as our enterprisewide optimization efforts helped lower our unit cash costs and tightened our spending control on SG&A, which helped offset lower average selling prices.
When stepping back and looking at our fourth quarter Salt costs, we ended up at $41 per ton, which is flat with the 2019 fourth quarter.
However, on a mix-adjusted basis, our unit cost is about $1.25 per ton lower than prior year.
So we absorbed a 25% decline in year-over-year fourth quarter Salt sales volume and we were still able to decrease our mix adjusted Salt unit costs versus the prior year.
Improved production and logistics costs in our North American highway business for the full year 2020 helped to offset a 12.4% lower salt revenue and resulted in adjusted operating income declining just 6% and an adjusted EBITDA decrease of only 2% year-over-year.
In addition to improved Goderich mine production, we continued to diligently and aggressively implement initiatives across the organization design to ultimately drive revenue higher and costs lower.
These efforts contributed to the expansion of the Salt segment adjusted operating margin to nearly 21% from about 19% last year and, at the same timem driving adjusted EBITDA margin to 29.3% compared to 26.1% for the full year 2019.
While these initiatives are expected to drive sustainable improvements for all segments over time, we continue to be pleased to see these early benefits in our Salt results.
It's also worth noting that these benefits have been muted a bit, given the difficult weather backdrop and the real value creation potential will be more obvious under better business conditions.
Turning to our Plant Nutrition North America segment.
Fourth quarter total sales revenue increased 15.9% from the prior year to $88.7 million.
We achieved this by delivering a 23% increase in sales volumes, partially offset by a 6% lower average selling prices.
As we have discussed in recent quarters, the extreme wildfire conditions in the Western U.S. delayed the start of the fall application season and, as we expected, shifted the timing of SOP sales volumes for the 2020 fourth quarter.
While we always price to drive the appropriate value proposition for our customers, we continue to maintain our market share for our premium Potassium+ SOP product.
Plant Nutrition North America operating earnings and EBITDA for the fourth quarter were pressured by short-term cost increases associated with feedstock inconsistency, unplanned downtime and related maintenance costs at our SOP facility in Utah, which weighed significantly on the quarterly and full-year results.
In turn, our Plant Nutrition North America EBITDA margin compressed to about 20% in the quarter compared to nearly 34% in the prior year, with operating margins declining about 10 percentage points quarter-over-quarter.
Strong full year sales volumes, partially offset by lower sales prices, helped us deliver a 16.2% improvement in 2020 full year Plant Nutrition North America revenue versus 2019.
These revenue results, coupled with the short-term fourth quarter cost pressure and the previously disclosed $7.4 million inventory adjustment in the third quarter, resulted in a $10.4 million decline in operating income and a $14.6 million decrease in full-year EBITDA.
Excluding the inventory adjustment, full-year operating margin would have been 8.1% compared to 10.9% in 2019, while full-year EBITDA margin would have been 25% versus 32.5% last year.
Because the inventory adjustment is non-recurring and our SOP cost pressure is short term in nature, we expect a sharp rebound in the Plant Nutrition North America EBITDA and operating margin percentages in 2021.
Our Plant Nutrition South America segment delivered a 24% year-over-year increase in fourth quarter 2020 revenue and an 18% increase for the full year, both in local currency.
This was driven by increases in average selling prices for both agriculture and chemical solutions products, along with stronger year-over-year agro sales volume.
Fourth quarter agro revenue was up about 29% versus 2019 and up nearly 23% for the full year.
Even more impressive was our fast growing Ag B2C business unit where strong sales volumes and price drove a 37% increase in both our 2020 fourth quarter and full year revenue when compared to prior year, again, all in local currency.
Strong demand began in early 2020 for many of our Specialty Plant Nutrition products due to the very attractive economics for Brazilian farmers and that trend continued as we finished 2020 and moved into the beginning of 2021.
In local currency, our Plant Nutrition South America fourth quarter and full year 2020 operating earnings increased 16% and 35%, respectively, while EBITDA increased in lockstep by 15% and 25%, as well.
While we're obviously disappointed with our fourth quarter and full year 2020 results, it's important to again point out that the combination of weak winter weather, Brazilian currency devaluation and COVID-19 impacts in both mitigation costs and end market deterioration negatively affected our 2020 full-year operating income by nearly $70 million.
Despite this impact, we were able to hold year-over-year adjusted EBITDA margins flat at 21% and generate more than $175 million cash flow from operations and $90 million of free cash flow.
I would now like to shift gears and spend a few minutes on our 2021 outlook.
As a reminder, when we work through our annual planning process, we utilize an underlying assumption of average winter weather and how that would translate through our upcoming bid season.
There are multiple scenarios we run, but at the end of the day, we focus on what we can control and then manage through the consequences of what the weather and other opportunities or challenges bring by adjusting our plan dynamically throughout the year.
We are extremely disciplined in our approach to capital spending and closely monitor the supply and demand dynamics of both the salt market, particularly in North America, and the specialty fertilizer market where our high-value Potassium+ SOP product has a leading market share in North America.
Should those factors dictate a supply response, we feel strongly that we can quickly adjust to make rational economic decisions and still be ready to meet our customers' needs.
We're optimistic about 2021 as we look for normalized sales volumes in our Salt business and the expectation of even better agriculture fundamentals in both North and South America.
The initial benefits of our optimization efforts have started to register throughout our various segments and while we're not providing specific guidance on the expected benefits, we continue to believe that the long-term commercial and operational advantages from these efforts will be meaningful to our bottom-line.
For the full year 2021, we are expecting consolidated adjusted EBITDA of between $330 million and $360 million, which is a year-over-year increase of about 20%.
While the midpoint of our guidance is at the lower end of last year's full-year guidance, it's important to note that weak winter weather impacts, like those in 2020, are never immediately reset as prior bid season pricing almost always has a significant influence on the following years' average selling prices.
Our annual operating plan anticipates approximately $100 million in 2021 capital spending, as well as free cash flow at levels similar to 2020.
We are forecasting a significant increase in Salt volumes as winter weather normalizes in both North America and the U.K., and we're expecting high-single-digit sales volume growth for our Plant Nutrition South America segment.
Within Plant Nutrition North America, we expect to see volumes down slightly compared to 2020 as we continue to monitor the growing season and balance our customer needs, given the recent ramp-up in pricing.
Importantly, we will continue working to offset any 2021 headwinds through a dual focus on value creation and cost containment through our enterprisewide optimization effort.
While our net debt to adjusted EBITDA ratio ended 2020 at about 4.3 times, it is expected to end 2021 below 4 times.
We expect to also continue to make progress improving our balance sheet and maintaining a very strong liquidity position with very little in near-term debt maturities.
In summary, while 2020 has been a year marked by challenges, not only for our company, but globally, our business model worked and our people withstood the test.
We exercised flexibility, managed external factors beyond our control, executed our plan and worked on our long-term strategy, while continuing to return cash to shareholders.
As we enter the new year, we remain focused on keeping our people safe, optimizing our operations, containing costs and delivering our essential products to satisfied customers around the world.
With that, I will ask the operator to begin the Q&A session.
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assuming average winter weather activity, expects modest salt segment revenue growth for h1 2021 versus 2020.
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Reconciliations of these measures to the most directly comparable GAAP measures are included in the appendix and posted on our website.
We appreciate your interest in CMS Energy.
Over the past five months, I have been on the -- the virtual road and have had the opportunity to meet with many of you to share our investment thesis, which delivers for all our stakeholders.
This thesis is grounded in our commitment to the triple bottom line of people, planet and profit and enable the excellence you have come to expect from CMS Energy.
Many of you have asked what will change under my leadership.
And I want to reemphasize, we've changed leadership not the simple proven investment thesis we delivered year in and year out.
Looking forward, we're committed to leading the clean energy transformation with our net zero carbon and methane emissions plans, which are supported by our clean energy investments in our current progressive integrated resource plan.
Furthermore, we are recognized as top tier for ESG performance earning top ratings among our peers.
We continue to mature our industry-leading lean operating system the CE Way eliminating waste and improving our performance.
I love this system.
Over the past several years, we have used it across the business to drive efficiencies, improve employee engagement and deliver sustainable cost performance.
I've seen it, I've worked it, and we have plenty of gas that are left.
Today we are crafting the next horizon what I call CE Way 2.0, which layers in greater use of automation and analytics and begins to position CMS Energy, as a leader in digital.
Another key differentiator of CMS Energy is Michigan's Top-tier regulatory construct that has 10-month forward looking rate cases in constructive ROEs.
This all leads to our adjusted earnings per share growth of 6% to 8% and combined with our dividend provides a premium total shareholder return of 9% to 11%.
At CMS Energy, we wake up every day to get after it, deliver for our customers in all conditions, rain, snow, sleet wind.
And for you, our investors, we never quit.
This year is no different.
Now, let's get into the numbers.
In the first quarter, we delivered $1.21 of adjusted earnings per share.
This is up significantly, $0.35 from last year, primarily from incremental revenue to fund needed customer investments and sustained cost performance.
As a reminder, our full year dividend is $1.74, up 7% from last year.
We are reaffirming our 2021 guidance for the year of $2.83 to $2.87 of adjusted earnings per share and our long term earnings and dividend per share growth of 6% to 8% with the bias to the midpoint.
At CMS Energy was committed to our promises to our co-workers, the communities we serve, and our planet, as we are to delivering our financial commitments.
During my discussions with many of you, the topic of ESG often comes up.
I'm proud of our leadership in this space.
We continue to enhance our commitments and our efforts are being recognized with top tier ratings.
We remain a AA rated company by MSCI and have ranked top quartile for global utilities by Sustainalytics since 2013.
This is a deep commitment that began well before it was a trend.
Our commitment -- our commitments to net zero methane emissions by 2030 and net zero carbon emissions by 2040 are among the most aggressive in the industry.
As our industry approach is a cleaner energy future, and we retire our legacy generating units, it is critical that we honor the contributions and service of our co-workers, as well as address the economic impact on those communities.
Now, I began my career on the generation side of our business.
I have walked the halls, climbed the stairs of every one of our generating plants, shaking hands, drink coffee with the men and women, who work every day to provide energy for our customers.
And I'm proud of the honorable and equitable way, we have cared for both our co-workers and our communities, as we retire these units from service.
We've built a playbook for success.
It began with the retirement of our seven coal plants in 2016.
That work will continue with the retirement of Karn 1 and 2 in 2023.
Our leadership and track record in this space is something I'm proud of and we'll continue, as we look to the future.
This ensures ensure success for all stakeholders, including our investors.
Our main focus is on the E of ESG.
We have a strong record of delivering across all three.
In my 20 years of service, I believe our culture has never been stronger.
Every single day, our co-worker show up with a heart of service for our customers, our communities, and ultimately you, our investors.
Our culture anchored by our values is thriving across our company and it's why we're recognized for top quartile safety performance, industry leading employee engagement, Forbes Best Employer for Women, Best for Vets by Military Times and Best Places to Work for LGBTQ Equality in the Corporate Equality Index.
And earlier this month, we were ranked by Forbes, as the number one utility in the country, as Best Employers for Diversity.
Our leadership, commitment and top tier ESG performance should provide you with the confidence that our long track record will continue to deliver value for customers and investors.
Turning to recent updates.
I want to highlight our continued growth in renewables with several exciting announcements.
We are pleased to announce the recent commission approval of our Heartland Wind project in March, which will be online in December of next year.
This project adds 201 megawatts of new capacity, as a part of our renewable portfolio standard earning a 10.7% return.
I'm also pleased to share that we received approval for the first tranche of our current Integrated Resource Plan, which adds nearly 300 megawatts of new solar through two projects that we expect to come online in 2022.
We are evaluating the second tranche of our current IRP, another 300 megawatts of solar expected to come online in 2023.
And the third tranche 500 megawatts of solar expected to come online in 2024 for a total of 1,100 megawatts.
We're on track to file our next Integrated Resource Plan in June.
It has been a popular topic in -- in our meetings with many of you, while we're still finalizing the details, the focus of our upcoming IRP will be to accelerate the decarbonization of our fleet, ensure reliability and affordability and add renewable and demand side resources in a way that makes sense for our customers and investors, while maintaining a healthy balance sheet.
I'm excited for this next IRP.
It serves as yet another proof point that we are leading the clean energy transformation.
As part of our clean energy transformation -- part of our clean energy transformation includes retirement of our remaining coal fleet.
On Slide 7, you will see our plan to decarbonize is both visible and data driven.
The meaningful reduction of carbon emissions in our plan will drive our ability to achieve net zero carbon emissions by 2040.
Over the past few months, I've been asked quite a bit about the future of our gas business.
As I've shared with many of you our gas business and system is critical to providing affordable and reliable heating here in Michigan.
But it doesn't mean, we're -- we're sitting on our tails here.
In fact, we are actively working to decarbonize our gas system.
Now this aligns very well with the recent announcement from the Biden administration.
Our first step is to reduce fugitive methane emissions, which is well under way, as we accelerate the replacement of vintage mains and services both plants approved by the commission will decrease our missions and achieve our net zero methane goal.
Our decarbonization plans also leverage energy efficiency to reduce carbon usage and put renewable natural gas on our system, which will help decarbonize most difficult sectors, such as agriculture.
By replacing vintage mains and services with plastic piping, we will be positioned to deliver hydrogen or other clean molecules to our customers in the future.
As we would grow our renewable portfolio and decarbonize our generation fleet and gas delivery system, we remain committed to delivering against the triple bottom line of people, planet and profit.
It demonstrates our consistent industry leading performance for nearly two decades.
As much as things change, one thing stays consistent, year in and year out we have and we'll continue to deliver.
2020 proved this, 2021 will be no different marking 19 years of consistent, predictable financial performance.
As Garrick highlighted, we're pleased to report our first quarter results for 2021.
In summary, we delivered adjusted net income of $348 million or $1.21 per share.
For comparative purposes, our first quarter adjusted earnings per share was $0.35 above our Q1, 2020 results, largely driven by rate relief, net of investment-related expenses, better weather and sustained cost performance from our 2020 efforts at the utility.
Our enterprises and parent and other segments were slightly down as planned due to the absence of a one-time cost reduction item in 2020 and higher funded -- funding related costs respectively.
This modest negative variance was more than offset by strong origination growth at EnerBank, which exceeded its Q1, 2020 earnings per share contribution by $0.06 in 2021 as planned and is tracking toward the high end of our guidance for the year of $0.22 per share.
The waterfall chart on Slide 10 provides more detail on the key year-to-date drivers of our financial performance versus 2020 and highlights our latest estimates for the major year-to-go drivers to meet our 2021 earnings per share guidance range.
To elaborate on the year-to-date performance, while weather in the first quarter of 2020 has been below normal to-date, which has led to lower volumetric gas sales, it has been better than the historically warm winter weather experienced in the first quarter of 2020.
And the absence of that weather has led to $0.08 per share of positive variance period-over-period.
From a rates perspective, given the constructive regulatory outcomes achieved in the second half of 2020 for our electric and gas businesses, we're seeing $0.26 per share of positive variance.
As a reminder, our rate relief estimates are stated net of investment related costs, such as depreciation and amortization, property taxes and funding costs.
It is also worth noting that our 2021 financials reflect the accelerated amortization of deferred taxes, as part of our 2020 gas rate order settlement.
On the cost side as noted during our fourth quarter earnings call, we budgeted substantial increases in our operating and maintenance expenses in 2021 versus the prior year to fund key initiatives around safety, reliability, customer experience and decarbonization and in alignment with our recent rate orders.
As you can see, we're $0.02 per share above our spend rate in the first quarter of 2020 as planned, and I'm pleased to report that we're seeing sustained cost performance from 2020, as well as increased productivity in 2021, largely attributable to the CE Way.
That said, we do expect to see the bulk of the planned O&M increases to materialize later in the year.
The balance of our year-to-date performance is driven by the aforementioned drivers at our non-utility segment and non-weather sales, which though slightly down at about 1% below the first quarter 2020 continue to exhibit favorable mix with the higher margin residential class, up 2% versus Q1 of 2020.
And I'll remind you that our total electric sales exclude one large low margin customer.
As we look ahead to the remaining nine months of 2021, we are cautiously optimistic about the glide path illustrated on this slide to achieve our full year earnings per share guidance.
As always, we plan for normal weather, which in this case translates to $0.12 per share of negative variance given the above normal weather experienced in the second and third quarters of 2020.
The residual impact of the aforementioned rate relief, which equates to $0.22 per share of pickup and is not subject to any further MPSC actions.
And the continued execution of our operational and customer-related projects, which we estimate as an incremental $0.18 per share of spend versus the comparable period in 2020.
We have also seen the usual conservatism in our utility, non-weather sales and our non-utility segments.
All in, we are pleased with our strong start to the year and are well positioned for the remaining three quarters of 2021.
And needless to say, we will be prepared to flex costs up or down, as the fact pattern evolves over the course of the year.
As we look out over the long term, we are in the early stages of executing our $13.2 billion five-year customer investment plan at the utility, which is highlighted on slide 11 and will provide significant benefits for our customers, the communities we serve and our investors.
As a reminder, we have budgeted over $2.5 billion of investments in 2021.
The vast majority of which is earmarked for safety, reliability and clean energy projects.
We are on track thus far, and recently filed an electric rate case in March that enumerate our customer investment priorities for the 2022 test year, which are summarized on the right hand side of the page among other key details related to the filing.
We expect an order from the commission by the end of the year.
Despite the substantial customer investments that we intend to make on our electric and gas system over the next several years, as you know we take great pride in taking out costs in a sustainable way to maintain affordable bills for our customers, and we have the track record to prove it.
The left hand side of slide 12 summarizes the key components of our cost structure, which we have successfully managed over the past several years, while investing significant capital on behalf of customers.
In fact from 2017 to 2019, we reduced utility bills, as a percentage of customer wallet by 1%, while investing roughly $19 billion of capital in the utility over that timeframe.
As we look ahead, we have several highly actionable event driven cost reduction opportunities, which will provide substantial savings in the years to come.
The planned expiration of our Palisades power purchase agreement and the recently approved amendment to our MCV PPA will collectively generate roughly $150 million of power supply cost recovery savings.
And as you'll note, our initial estimates for the potential savings for the MCV contract amendment of approximately $50 million proved conservative with the revised estimate of over $60 million in savings, per the commission's order in March.
Also the planned retirements of our five remaining coal unit should provide another $90 million of savings in aggregate, exclusive of any potential fuel cost savings, which will create meaningful headroom and bills for future customer investments.
Lastly, I'd be remiss if I didn't mention our annual O&M productivity delivered through the CE Way, which last year generated roughly $45 million of savings and serves as a critical tool to our long term and intra-year financial planning.
To that end, many of you've asked about proposed changes in corporate tax policy and its potential impact to our plan.
Though at this point, the final details remain unclear, trust that we are evaluating the potential effects and we'll leverage the CE Way and other cost reduction opportunities, including potential offsetting tax credits that are also being proposed, as part of the legislation to minimize the impact to customers, while executing our capital plan.
As we've said before, it is our job to do the warring for you, and we are uniquely positioned over the next several years to manage any potential headwinds.
With our unparalleled track record on cost management, driven by our highly engaged workforce coupled with a robust customer investment backlog and top tier regulatory construct, we are confident that we can deliver on our ambitious, operational, customer and financial objectives for the foreseeable future.
And with that we'll move to Q&A.
Mr. Racho, please open the lines.
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compname announces first quarter earnings results of $1.21 per share, reaffirms 2021 guidance.
q1 adjusted earnings per share $1.21.
q1 earnings per share $1.21.
compname says reaffirmed its guidance for 2021 adjusted earnings of $2.83 - $2.87 per share.
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Reconciliations of these measures to the most directly comparable GAAP measures are included in the appendix and posted on our website.
I'm going to start today with the end in mind, strong quarter and a great first half of the year, giving us confidence as we target the high end of the guidance range.
Rejji will walk through the details of the quarter, and I'll share what the strong results mean for 2021 earnings.
Needless to say, I'm very pleased.
An important gene sale of EnerBank at 3 times book value, moving from noncore to the core business with a strong focus on regulated utility growth.
The sale of the bank provides for greater financial flexibility, eliminating planned equity issuance from 2022 to 2024.
And in the end, Reggie will share how we have reduced our equity issuance need for 2021 in today's remarks.
Furthermore, with the filing of our integrated resource plan, you can see the path for more than $1 billion into the utility, again, without equity issuance.
Not only is there visibility to that investment, that's certainly in the time line for review.
I'm excited about this IRP.
It's a remarkable plan.
Many have set net zero goals.
We have industry-leading net zero goals and this IRP provides a path and is an important proof point in our commitment.
We are leading the clean energy transformation.
It starts with our investment thesis.
This simple but intentional approach has stood the test of time and continues to be our approach going forward.
It is grounded in a balanced commitment to all our stakeholders and enables us to continue to deliver on our financial objectives.
With the sale of EnerBank and the plan to exit coal by 2025, our investment thesis gets even simpler.
But now it's also cleaner and leaner.
We continue to mature and strengthen our lean operating system, the CE Way, which delivers value by reducing cost and improving quality, ensuring affordability for our customers, and our thesis is further strengthened by Michigan's supportive regulatory construct.
All of this supports our long-term adjusted earnings per share growth of 6% to 8%, and combined with our dividend, provides a premium total shareholder return of 9% to 11%.
All of this remains solidly grounded in our commitment to the triple bottom line of people, planet and profit.
As I mentioned, our integrated resource plan provides the proof points to our investment thesis, our net zero commitments and highlights our commitment to the triple bottom line by accelerating our decarbonization efforts, making us one of the first utility in the nation to exit coal or increasing our renewable build-out, adding about eight gigawatts of solar by 2040, two gigawatts from the previous plan.
Furthermore, this plan ensures reliability, a critical attribute as we place more intermittent resources on the grid.
The purchase of over two gigawatts of existing natural gas generation allows us to exit coal and dramatically reduces our carbon footprint.
Existing natural gas generation is key.
And like we've done historically with the purchases of our Zeeland and Jackson generating stations.
This is a sweet spot for us where we reduce permitting, construction and start-up risk.
It is also thoughtful and that is not a 40- to 50-year commitment that you would get with a new asset, which we believe is important, as we transition to net zero carbon.
And, yes, on other hand, our plan is affordable for our customers.
It will generate $650 million of savings, essentially paying for our transition to clean energy.
This is truly a remarkable plan.
It is carefully considered and data-driven.
We've analyzed hundreds of scenarios with different sensitivities and our plan was thoughtfully developed with extensive stakeholder engagement.
I couldn't be more proud of this plan and especially the team that put it together.
We've done our homework, and I'm confident it is the best plan for our customers, our coworkers, for great state of Michigan, of course, you, our investors to hit the triple bottom line.
The Integrated Resource Plan is a key element of Michigan's strong regulatory construct, which is known across the industry as one of the best.
It is a result of legislation designed to ensure a primary recovery of the necessary investments to advance safe and reliable energy in our state.
It enables us and the commission to align on long-term generation planning and provide greater certainty as we invest in our clean energy transformation.
We anticipate an initial order for the IRP from the commission in April and a final order in June of next year.
The visibility provided by Michigan's regulatory construct enables us to grow our capital plan to make the needed investments on our system.
On Slide six, you can see that our five-year capital plan has grown every year.
Our current five-year plan, which we'll update on our year-end call includes $13.2 billion of needed customer investment.
It does not contain the upside in our IRP.
The IRP provides a clear line of sight to the timing and composition of an incremental $1.3 billion of opportunity.
And as I shared on the previous slide, the regulatory construct provides timely approval of future capital expenditures.
I really like this path forward.
And beyond our IRP, there is plenty of opportunity for our five-year capital plan to grow given the customer investment opportunities we have in our 10-year plan.
Our backlog of needing investments is as vast as our system, which serves nearly seven million people in all 68 counties of Michigan's Lower Peninsula.
We see industry-leading growth continuing well into the future.
So where does that put us today?
The bank sale and now the IRP filing provide important context for our future growth and positioning of the business.
Let me share my confidence.
For 2021, we are focused on delivering adjusted earnings from continuing operations of $2.61 to $2.65 per share, and we expect to deliver toward the high end of that range.
For 2022, we are reaffirming our adjusted full year guidance of $2.85 to $2.87 per share.
Given the strong performance we are seeing this year, the reduced financing needs next year and continued investments in the utility, there is upward momentum as we move forward.
Now many of you have asked about the dividend.
We are reaffirming again no change to the $1.74 dividend for 2021.
As we move forward, we are committed to growing the dividend in line with earnings with a target payout ratio of about 60%.
It's what you expect, it's what you own it, and it is big part of our value.
I will offer this.
Our target payout ratio does not need to be achieved immediately, it will happen naturally, as we grow our earning.
Finally, I want to touch on long-term growth rate, which is 6% to 8%.
This has not changed.
It's driven by the capital investment needs of our system, our customers' affordability and the need for a healthy balance sheet to fund those investments.
Historically, we've grown at 7%.
But as we redeploy the proceeds from the bank, we will deliver toward the high end through 2025.
I'll also remind you that we tend to rebase higher off of actuals.
We have historically either met or exceeded our guidance.
All in, a strong quarter, positioned well for 2021 with upward momentum and with EnerBank and the IRP, it all comes together nicely positioned for the long term.
Before I walk through the details of our financial results for the quarter, you'll note that throughout our materials, we have reported the financial performance of EnerBank as discontinued operations, thereby removing it as a reportable segment and adjusting our quarterly and year-to-date results in accordance with generally accepted accounting principles.
And while we're on EnerBank, I'll share that the sale process continues to progress nicely, as the merger application was filed in June with the various federal and state regulators will be evaluating the transaction for approval, and we continue to expect the transaction to close in the fourth quarter of this year.
Moving on to continuing operations.
For the second quarter, we delivered adjusted net income of $158 million or $0.55 per share, which excludes $0.07 from EnerBank.
For comparative purposes, our second quarter adjusted earnings per share from continuing operations was $0.09 above our second quarter 2020 results, exclusive of EnerBank's earnings per share contribution last year.
The key drivers of our financial performance for the quarter were rate relief, net of investment-related expenses, recovering commercial and industrial sales and the usual strong tax planning.
Year-to-date, we delivered adjusted net income from continuing operations of $472 million or $1.64 per share, which excludes $0.19 per share from EnerBank and is up $0.37 per share versus the first half of 2020, assuming a comparable adjustment for discontinued operations.
All in, we're tracking well ahead of plan on all of our key financial metrics to date, which offers great financial flexibility for the second half of the year.
The waterfall chart on Slide nine provides more detail on the key year-to-date drivers of our financial performance versus 2020.
As a reminder, this walk excludes the financial performance of EnerBank.
For the first half of 2021, rate relief has been the primary driver of our positive year-over-year variance to the tune of $0.36 per share given the constructive regulatory outcomes achieved in the second half of 2020 for electric and gas businesses.
As a reminder, our rate relief figures are stated net of investment-related costs, such as depreciation and amortization, property taxes and funding costs at the utility.
The rate relief related upside in 2021 has been partially offset by the planned increases in our operating and maintenance expenses to fund key initiatives around safety, reliability, customer experience and decarbonization.
As a reminder, these expenses align with our recent rate orders and equate to $0.06 per share of negative variance versus 2020.
It is also worth noting that this calculation also includes cost savings realized to date, largely due to our waste elimination efforts through the CE Way, which are ahead of plan.
We also benefited in the first half of 2021 from favorable weather relative to 2020 in the amount of $0.06 per share and recovering commercial and industrial sales, which coupled with solid tax planning provided $0.01 per share of positive variance in aggregate.
As we look ahead to the second half of the year, we feel quite good about the glide path to delivering toward the high end of our earnings per share guidance range, as Garrick noted.
As always, we plan for normal weather, which in this case, translates to $0.02 per share of negative variance, given the absence of the favorable weather experienced in the second half of 2020.
We'll continue to benefit from the residual impact of rate relief, which equates to $0.12 per share of pickup.
And I'll remind you, is not subject to any further MPSC actions.
We also continue to execute on our operational and customer-related projects, which we estimate will have a financial impact of $0.21 per share of negative variance versus the comparable period in 2020 given anticipated reinvestments in the second half of the year.
We have also seen the usual conservatism in our utility non-weather sales assumptions and our nonutility segment performance, which as a reminder, now excludes EnerBank.
All in, we are pleased with our strong start to the year and are well positioned for the latter part of 2021.
Turning to our financing plan for the year.
I'm pleased to highlight our recent successful issuance of $230 million of preferred stock at an annual rate of 4.2%, one of the lowest rates ever achieved for a preferred offering of its kind.
This transaction satisfies the vast majority of funding needs of CMS Energy, our parent company for the year and given the high level of equity content ascribed to the security by the rating agencies, we have reduced our planned equity issuance needs for the year to up to $100 million from up to $250 million.
As a reminder, over half of the $100 million of revised equity issuance needs for the year are already contracted via equity forwards.
It is also worth noting that given the terms and conditions of the EnerBank merger agreement in the event EnerBank continues to outperform the financial plan prior to the closing of the transaction, we would have a favorable purchase price adjustment related to the increase in book equity value at closing, which could further reduce our financing needs for 2021 and provide additional financial flexibility in 2022.
Closing out the financing plan, I'll also highlight that we recently extended our long-term credit facilities by one year to 2024, both at the parent and the utility.
Lastly, I'd be remiss if I didn't mention that later today, we'll file our 10-Q, which will be the last 10-Q owned by Glenn Barba, our Chief Accounting Officer, who most of you know from his days leading our IR team.
Glenn announced his retirement earlier this year after serving admirably for nearly 25 years at CMS, which included him signing over 75 quarterly SEC filings during his tenure.
As we've highlighted today, we've had a great first half of the year.
We are pleased to have delivered such strong results.
We're positioned well to continue that momentum into the second half of the year as we focus on finalizing the sale of the bank and moving through the IRP process.
I'm proud to lead this great team, and we can't wait to share our success as we move forward together.
This is an exciting time at CMS Energy.
With that, Rocco, please open the lines for Q&A.
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reaffirms fy adjusted non-gaap earnings per share view $2.61 to $2.65 from continuing operations.
reaffirms fy adjusted earnings per share view $2.85 to $2.87.
q2 adjusted earnings per share $0.55 from continuing operations.
q2 earnings per share $0.55 from continuing operations.
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Reconciliations of these measures to the most directly comparable GAAP measures are included in the appendix and posted on our website.
I'm pleased to share we've delivered another strong quarter and continue to be ahead of plan for the year.
I'll walk through the specifics in a moment, but I couldn't be more pleased with the strong execution demonstrated by the team, both operationally and financially.
We continue to deliver every day for our customers, coworkers and for you, our investors.
Earlier this month, we completed the sale of EnerBank, grossing over $1 billion in proceeds.
The sale of the bank simplifies and focuses our business model squarely on energy, primarily the regulated utility, an important step as we continue to lead the clean energy transformation.
The proceeds from this sale will fund key initiatives in our utility business related to safety, reliability, resiliency and our clean energy transformation.
As shared in previous calls, we have eliminated our equity needs from 2022 through 2024.
The keyword there, continued.
As we double down on the clean energy transformation, I'm also pleased to share that we received approval for our Voluntary Green Pricing program, which would add an additional 1,000 megawatts of owned renewable generation to our growing renewable portfolio.
This program is in high demand and currently oversubscribed.
And more importantly, it's what our customers are asking for, an important step in offering renewable energy solutions for our customers.
As we prepare for the grid of the future, we have a highly visible and detailed capital plans outlined in our recently filed electric distribution infrastructure investment plan.
This plan provides a 5-year view of the projects down to the circuit level where we plan to invest to ensure the reliability and resiliency of our electric infrastructure and aligns with our operational and financial plans.
As always, we balance these investments with customer affordability.
Our prices remain competitive as the average residential customer pays about $2 a day to heat their home and $4 a day to keep the lights on.
And because we know our most vulnerable customers still struggle, our team has mobilized resources at the state and federal levels to ensure their protection.
In fact, as we approach the winter heating season, our 90-day arrears are back to prepandemic levels with an 80% reduction in our uncollectible accounts.
Our commitment to identifying and eliminating waste means that we keep our prices affordable.
This commitment is evident in our results.
In the first nine months of this year, we surpassed our full year cost reduction target of more than $40 million.
The CE Way is in our DNA, and we continue to deliver savings in the near term and well into the future.
Speaking of the future, this year, we grew our EV program with PowerMIFleet.
This is part of our long-term planning in collaboration with Michigan businesses, governments and school systems looking to electrify their vehicle fleets.
Within just a few months of the program introduction, we were working with nearly 20 different customers on their fleets and have another 50 who have indicated interest in the next tranche, exceeding our expectations.
This is an important contribution to our long-term sales growth.
And finally, one of my favorites which speaks to our culture, our coworkers and our ability to attract the best talent.
Our commitment to diversity, equity and inclusion continues to be recognized nationwide and most recently by Forbes, where we were ranked the #1 utility in the U.S. for both America's best employers for women and #1 for diversity, delivering excellence every day continues to position the business for sustainable long-term growth.
Strong execution leads to strong results.
but two are linked.
One drives the other.
In early August, we experienced one of the worst storms in our company's history.
Our team established and into command structure to deploy resources and took decisive action to restore customers.
We had a record number of crews on our system.
The speed of our response led to the highest positive customer sentiment we have ever received during a major storm.
During the storm, we had more than 3,700 members of our team working around the clock to safely restore customers.
Like we do every year, through storms, pandemics, and on seasonal weather, we continue to deliver.
And when there's upside, we reinvest.
This is the CMS model of responding to changing conditions that allows us to deliver consistently year after year.
Year-to-date, we've delivered ahead of plan with adjusted earnings per share of $2.18 for continuing operations.
Our strong performance, coupled with the completion of the EnerBank transaction and the financial flexibility that provides -- gives us further confidence in our ability to meet our full year guidance, which we've raised to $2.63 to $2.65 from $2.61 to $2.65 for continuing operations.
For 2022, we are reaffirming our adjusted full year guidance of $2.85 to $2.87 per share.
And our continued strong performance in 2021 builds momentum for 2022 and beyond.
Longer term, we are committed to growing our adjusted earnings per share toward the high end of our 6% to 8% growth range as we highlighted on our Q2 call.
As previously stated, we are committed to growing the dividend in 2022 and beyond.
That's what you expect, why you own us, and we know it's a big part of our value.
As we move forward, we continue to see long-term dividend growth of 6% to 8% with a targeted payout ratio of about 60% over time.
Many of you have asked about gas prices and the impact on our business and more importantly, our customers.
Let me tell you about our gas business.
We have one of the largest storage field in the U.S. and compressing resources to match.
That is a significant advantage.
We started putting natural gas into our storage field in April and continued throughout the summer when natural gas prices were low.
Right now, our fields are full and ready to deliver for our customers' heating needs throughout the winter months.
Most of the gas is already locked in at just under $3 per thousand cubic feet, which is well below current levels in the spot market and offers tremendous customer value.
Given the operational certainty of storage as well as the financial protection of a pass-through clause, our customers stay safe and warm all winter long and have affordable bills.
Heat in Michigan is not an option.
And we don't leave it up to the market.
We buy, store and deliver.
That's what we do.
Michigan's strong regulatory construct is known across the industry as one of the best.
It includes the integrated resource plan process, which is a result of legislation designed to ensure timely recovery of the necessary investments to advance safe, reliable and clean energy in our state.
It enables the company and the commission to align on long-term generation supply planning and provide certainty as we invest in our clean energy transformation.
Here's what I like about our recently filed IRP.
There is a win in it for everyone.
It is a remarkable plan that addresses many of the interests of our stakeholders and ensure supply reliability.
It reduces costs and it delivers industry-leading carbon emission reductions.
We continue to have constructive dialogue with the staff and other stakeholders, and we anticipate seeing their positions later today.
I'm pleased to offer the details of another strong quarter of financial performance at CMS, as a result of solid execution across the company.
As a brief reminder, throughout our materials, we report the financial performance of EnerBank as discontinued operations thereby removing it as a reportable segment in reporting our quarterly and year-to-date results from continuing operations in accordance with generally accepted accounting principles.
Now on to the results.
For the third quarter, we delivered adjusted net income of $156 million or $0.54 per share.
The key drivers for the quarter were higher service restoration expenses, attributable to the August storms that Garrick mentioned and planned increases in other operating and maintenance expenses in support of key customer and operational initiatives.
These sources of negative variance for the quarter were partially offset by favorable weather, the continued recovery of commercial and industrial sales in our electric business and higher rate relief net of investment-related expenses.
Year-to-date, we've delivered adjusted net income of $628 million or $2.18 per share, which is up $0.19 per share versus the first nine months of 2020, exclusive of EnerBank's financial performance.
All in, we continue to trend ahead of plan and have substantial financial flexibility heading into the fourth quarter.
The waterfall chart on Slide eight provides more detail on the key year-to-date drivers of our financial performance versus 2020.
For the first nine months of the year, rate relief continues to be the primary driver of our positive year-over-year variance to the tune of $0.45 per share given the constructive regulatory outcomes achieved in the second half of 2020 for our electric and gas businesses.
As a reminder, our rate relief figures are stated net of investment-related costs such as depreciation and amortization, property taxes and funding costs at the utility.
This upside has been partially offset by the aforementioned storms in the quarter, which drove $0.16 per share of negative variance versus the third quarter of 2020 and $0.11 per share of downside on a year-to-date basis versus the comparable period in 2020.
To round out the customer initiatives bucket, planned increases in our operating and maintenance expenses to fund safety, reliability and decarbonization initiatives added the balance of spend for the first nine months of the year, which, in addition to the August storm activity, added $0.35 per share of negative variance versus the comparable period in 2020.
As a reminder, these cost categories are still net of cost savings realized to date, which as Garrick mentioned, have already exceeded our target for the year with more upside to come.
To close out our year-to-date performance, we also benefited from favorable weather relative to 2020 in the amount of $0.07 per share and another $0.02 per share of upside, largely driven by recovering commercial and industrial load.
As we look ahead to the remainder of the year, we feel quite good about the glide path for delivering on our earnings per share guidance range, which has been revised upward to $2.63 to $2.65 per share, as Garrick noted.
As we look ahead, we continue to plan for normal weather, which in this case, translates to $0.06 per share of positive variance, given the absence of the unfavorable weather experienced in the fourth quarter of 2020.
We'll also continue to benefit from the residual impact of our 2020 rate orders, which equates to $0.07 per share and is not subject to any further MPSC actions.
And we'll make steady progress on our operational and customer-related initiatives which are forecasted to have a financial impact of roughly $0.07 per share of negative variance versus the comparable period in 2020.
Lastly, we'll assume the usual conservatism in our utility non-weather sales assumptions and our nonutility segment performance.
All in, we are pleased with our strong execution to date in 2021 and are well positioned for the remainder of the year.
Turning to Slide 9.
I'm pleased to highlight that this year's financing plan has been completed ahead of schedule.
In the third quarter, we issued $300 million of first mortgage bonds at a coupon rate of 2.65%, one of the lowest rates ever achieved at Consumers Energy.
We also remarketed $35 million of tax-exempt revenue bonds earlier this month at a rate of under 1% through 2026.
Due to the strong execution implied by these record-setting issuances coupled with the EnerBank sale, which provided approximately $60 million of upside relative to the sale price announced at signing, we now have the flexibility to reduce our equity needs for the year even further, which will now be limited to the $57 million of equity forwards we have already contracted.
Our simple investment thesis has stood the test of time and continues to be our approach going forward.
It is -- it's grounded in a balanced commitment to all our stakeholders, enables us to continue to deliver on our financial objectives.
As we've highlighted today, we've executed on our commitment to the triple bottom line through the first nine months of the year.
We're pleased to have delivered strong results.
We're positioned well to continue that momentum into the last three months of the year as we move past the sale of the bank and continue progress to the IRP process.
This is an exciting time at CMS Energy.
With that, Rocco, please open the lines for Q&A.
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sees fy adjusted non-gaap earnings per share $2.63 to $2.65 from continuing operations.
reaffirms fy adjusted earnings per share view $2.85 to $2.87.
q3 adjusted earnings per share $0.54 from continuing operations.
q3 earnings per share $0.54 from continuing operations.
sees fy 2021 adjusted earnings from continuing operations in the range of $2.63 per share to $2.65 per share.
raised its full-year 2021 adjusted earnings from continuing operations guidance to $2.63 to $2.65 per share.
reaffirmed 2022 adjusted earnings guidance of $2.85 - $2.87 per share.
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Reconciliations of these measures to the most directly comparable GAAP measures are included in the appendix and posted on our website.
I've had the pleasure of meeting many of you over the past couple of months as I've transitioned into the CEO role.
I'm excited to be hosting my first earnings call and sharing yet another year of consistent industry-leading financial performance.
Before I discuss our year-end results and our updated five-year capital investment plan, I want to take a moment to reiterate our simple but powerful investment thesis, was simple to put on paper it's not easy to replicate, and that is what sets us apart.
It starts with our industry-leading commitments to clean energy.
Our net zero methane and carbon goals require significant investment as we update our expansive electric and gas systems to achieve decarbonization.
These investment opportunities are supported by constructive energy legislation as well as alignment with our Commission and the MPSC staff.
This strong regulatory and legislative framework is why Michigan is consistently ranked a top tier regulatory jurisdiction.
But investment opportunities in a supportive regulatory environment are not enough.
Our focus on affordability is critical, so our customers can afford these investment.
Now, I've been with the company for 18 years, much of it in operations.
Over that time, we've demonstrated our ability to consistently manage costs as we've invested in the safety and reliability of our systems while improving customer service.
That ability to manage costs is not driven from the top down but from the bottom up.
It's our 8,500 coworkers who are committed to excellence, delivering the highest value to our customers at the lowest cost possible.
This is embedded in our culture and was built in partnership with our union over the last two decades.
These unique attributes to the CMS story or would allow us to deliver for our customers and you, our investors.
Our adjusted earnings per share growth of 6% to 8% combined with our dividend provides a premium total shareholder return of 9% to 11%.
Our ability to deliver this growth each and every year is something we are uniquely capable of doing.
Regardless of weather, a global pandemic, who is leading our state, our Commission or our company, we have delivered consistent industry-leading results year-in and year out 2020 proved this, 2021 will be no different.
In 2020, we delivered adjusted earnings per share of $2.67, up 7% from 2019 and achieved operating cash flow of almost $2 billion, excluding $700 million of voluntary pension contributions in 2020.
Today, we're raising our adjusted earnings per share guidance for 2021 by $0.01 to $2.83 to $2.87 with a focus on the midpoint.
This reflects annual growth of 6% to 8% from our 2020 results.
Last month, we announced our 15th dividend increase in as many years, $1.74 per share, up 7% from the prior year.
We continue to target long-term annual earnings and dividend per share growth of 6% to 8%, again with a focus on the midpoint.
Today, we're also increasing our five-year capital plan to $13.2 billion, up $1 billion from our prior plan.
18 consecutive years of industry-leading financial performance.
I'll let that sit with you for a moment.
I'm pleased with our financial performance, but equally important is our commitment to the triple bottom line.
We balanced everything we do for our coworkers, customers and the communities we serve, our planet and our investors as demonstrated on Slide 6.
2020; 2020 was a tough year for everyone, the global pandemic impacted all of us emotionally, physically and financially.
Through it all, I'm proud of the work done by our coworkers.
We were able to provide over $80 million of support to our customers and communities in 2020 through support programs, low-income assistance, donations to foundations and reinvestment to improve safety and reliability.
We focused our efforts on COVID relief for residential and small business customers, payment forgiveness as well as enhanced support in the area of diversity, equity and inclusion.
This quite change in our work practices as a result of the pandemic, we maintained first quartile, employee engagement, achieved first quartile customer experience and attracted 126 megawatts of new load to our state, which brings with it significant investment and over 4,000 new jobs.
From a planet perspective, we continue to lead the clean energy transition.
We added over 800 megawatts of new wind and are executing on 300 megawatts of new solar.
The first tranche of our integrated resource plan.
Furthering our commitment, over $700 million of investments were made to advance our clean energy transition, additionally, our demand response and energy efficiency programs continue to save our customers money, reduce carbon and earn an incentive.
And last but certainly not least we finished the year with more than $100 million in cost savings driven by the CE Way.
Many of you have asked about my commitment to the CE Way, light blue arrow at the bottom of this slide in my experience leading this operating system over the past five years should be a strong signal.
I'll tell you this, we are positioned well but there is still more opportunity.
Through the CE Way, we will continue to improve reliability, reduce waste and deliver better customer service.
And that is just the tip of the iceberg, there are opportunities in every corner of the company to achieve excellence through the CE Way.
My coworkers and I remain committed.
We will continue to lead the clean energy transition with support from our new five-year $13.2 billion capital investment plan, which translates to over 7% annual rate base growth and focuses on enhancing the safety and reliability of our systems, as we move toward net zero carbon and methane emissions.
In fact, 40% of our plan directly supports our clean energy transition and includes our renewable generation, electric distribution investment to support this generation, grid modernization as well as programs like our main invented service replacement programs which reduce methane emissions.
In addition to our traditional rate base returns, our wind investments, renewable PPAs and demand side resources are supported by regulatory incentives above and beyond our ROE.
These incremental earnings mechanisms enhance our earned returns and combined with our investments in clean energy, our growing percentage of our earnings mix.
Our customers' ability to afford the investments in our system is complemented by our continued focus on cost savings.
Over the last decade, we have reduced the utility bill as a percentage of the customer's wallet and we continue to see further opportunity to reduce costs in the future.
We have unique cost saving opportunities relative to peers and two above market PPAs, Palisades and MCV, which will generate nearly $140 million of power supply cost recovery savings.
This coupled with the future retirement of our remaining coal facilities provides over $200 million or 5% cost savings for our customers.
These structural cost savings combined with the productivity we will deliver through the CE Way will ensure we deliver on our capital plan and keep customer bills affordable.
Now the great thing about the CE Way is it delivers more than cost savings.
What makes us unique is our engaged coworkers, we value our best-in-sector employee engagement and our 8,500 coworkers who work every day to deliver the best value for our customers.
This engaged workforce has doubled productivity which has enabled us to consistently increase our capital plan without significantly increasing our workforce.
Furthermore, we have never served our customers better as we move from the bottom quartile to top quartile not just in the utility industry but across all industries.
Slide 9 serves as an excellent example of how our team leverages the CE Way to deliver on our triple-bottom line.
Our ability to deliver this level of excellence for our customers and investors supported is by Michigan's constructive regulatory environment.
We benefit from a legislative and regulatory construct that supports our rate case proceeding and a statute that allows for financial incentives above and beyond current authorized ROE.
Michigan's regulatory jurisdiction has been ranked in the top tier since 2013.
That's not by accident, it's a reflection of the hard work my coworkers do every day to earn the trust of our customers, policy makers, environmental groups, EMV and MPSC Staff.
Turning to Slide 11, you know, we have a light regulatory docket with no financially significant regulatory outcomes in 2021.
With the approval of our current securitization and electric rate case in December of last year, we'll file our next electric rate case in the first quarter and our gas rate case in December of this year.
Notably, we'll file our second iteration of our integrated resource plan in June.
I'm sure many of you would like a sneak peek, but it's too early, we're in the midst of the modeling phase.
You can be confident that this next iteration will continue to build on industry-leading clean energy commitments and we'll find ways to get cleaner, faster and a corporate storage in customer-driven solutions as they become more cost effective.
Beyond that we'll ask you to stay tuned until our second quarter earnings call, we will provide more information after we file.
We're pleased to report our 2020 adjusted net income of $764 million or $2.67 per share, up 7% year-over-year off our 2019 actuals.
To elaborate on the key drivers of our year-end results, we realized increases in rate relief net of investments due to constructive orders in our recent gas and electric rate cases, strong performance in our non-utility segments and most notably our historic companywide cost reduction efforts led by the CE Way which Garrick noted earlier.
These positive factors were partially offset by mild weather and reinvestments or flex up back into the business.
We've talked in the past about our practice of flexing up, which enables us to put financial upside to work in the second half of the year to pull ahead or connect to work to improve the safety and reliability of our gas and electric systems to fund customer support programs, which was particularly important in 2020 given the effects of the pandemic, invest in coworker training programs and derisk our financial plan in subsequent years.
This tried and true approach benefits all stakeholders, which is the absence of the triple bottom line of people, planet and profit.
On Slide 13, you will note that we met our key financial objectives for the year.
To avoid being repetitive with Garrick's earlier remarks, I'll just note that we invested $2.3 billion of capital in our electric and gas infrastructure to the benefit of customers, including investments in wind farms, which add approximately $500 million of RPS related rate base, which I'll remind you earns a premium return on equity of 10.7%.
I'll also note that our treasury team had a banner year successfully raising approximately $3.5 billion of cost effective capital which includes roughly $250 million of equity while navigating turbulent capital market conditions over the course of 2020.
These efforts further strengthened our balance sheet to the benefit of customers and investors.
Turning the page to 2021, as mentioned, we are raising our 2021 adjusted earnings guidance to $2.83 to $2.87 per share, which implies 6% to 8% annual growth off our 2020 actuals.
Unsurprisingly, the majority of our growth will be driven by the utility and I'll also note a modest level of anticipated upside at the parent and other segment in 2021, largely due to the absence of select non-operating flex items executed in 2020.
All in, we will continue to target the midpoint of our consolidated earnings per share growth range of 7% at year-end, which is in excess of the sector average.
To elaborate on the glide path to achieve our 2021 earnings per share guidance range, as you'll note in the waterfall chart on Slide 15, we'll plan for normal weather, which in this case amounts to $0.06 per share of positive year-over-year variance given the mild winter weather experienced in 2020.
Additionally, we anticipate $0.41 of earnings per share pickup in 2021 attributable to rate relief net of investment costs largely driven by the orders received in the second half of 2020.
It is also worth noting that the magnitude of earnings per share impact here is in part due to the absence of an electric rate increase in 2020 which was a condition of our 2019 settlement agreement.
While we do plan to file an electric case in Q1 of this year, as Garrick mentioned, the test year and economic impact for that case will commence in 2022.
As we look at our cost structure in 2021 you'll note approximately $0.27 per share of negative variance attributable to incremental O&M approved in our recent rate cases to support key initiatives around safety, reliability customer experience and decarbonization, needless to say we have underlying assumptions around productivity and waste elimination, driven by the CE Way and we'll always endeavor to overachieve on those targets while delivering substantial value for our customers.
Lastly, we apply our usual conservative assumptions around sales, financings and other items.
And I'll note that while the pandemic remains relatively uncontested, we are assuming a gradual return of weather normalized load to pre-pandemic levels around mid-year.
In the event, the mass teleworking trend persists and/or we see an accelerated reopening of the Michigan economy, we can potentially see some upside from incremental, residential and commercial margin.
As always we'll adapt to changing conditions and circumstances throughout the year to mitigate risks and increase the likelihood of meeting our operational and financial objectives.
We're often asked whether we can sustain our consistent industry-leading growth in the long-term given the widespread concerns about economic conditions or potential changes in fiscal, energy and/or environmental policy?
And our answer remains the same, irrespective of the circumstances, we view it as our job to do the worrying for you.
Our familiar earnings per share chart on Slide 16 illustrates one of our key strengths, which is to identify and eliminate financial risk and capitalize on opportunities as they emerge to deliver additional benefits to customers while sustaining our financial success over the long term for investors, each year provides a different fact pattern.
And we've always risen to the occasion.
2020 offered some unique challenges resulting from the pandemic and more familiar source of risk in the form of mild winter weather.
And as usual, we didn't make excuses instead we offer transparency, devise our course of action and counted on the perennial will of our 8,500 co-workers to deliver for our customers, the communities we serve, and for you, our investors.
To summarize our financial objectives in the near and long term, we expect 6% to 8% adjusted earnings per share and dividend growth and strong operating cash flow generation.
From a balance sheet perspective, we continue to target solid investment grade credit ratings and we'll manage the key credit metrics accordingly.
One item I'll note in this regard is that we have slightly modified our FFO to debt targets to align better with the various rating agency methodologies.
Given the increase in our five-year capital plan, we anticipate annual equity need of up to $250 million in 2021 and beyond, which we are confident that we can comfortably raise through our equity dribble program to minimize pricing risk.
And two additional items I'll mention with respect to our financial strength as we kick off 2021 that are not on the page but no less important are that we concluded 2020 with $1.6 billion of net liquidity, which positions our balance sheet well as we execute our updated capital plan going forward.
And we have fully funded benefit plans for the second year in a row due to proactive funding.
The latter of which benefits roughly 3,000 of our active co-workers and 8,000 of our retirees.
Our model has served and will continue to serve all stakeholders well.
Our customers receive safe, reliable and clean energy at affordable prices while our co-workers remain engaged well trained and cared for in our purpose-driven organization, and our investors benefit from consistent industry-leading financial performance.
As you'll note with the reasonable planning assumptions, rate orders already in place in our track record of risk mitigation, the probability of large variances from our plan are minimized.
And with that, I'll hand it back to Garrick for some final comments before Q&A.
Our investment thesis remains simple but unique.
It enables us to deliver for all our stakeholders year in and year-out.
We remain committed to lead the clean energy transition, excellence through the CE Way and delivering our premium total shareholder return through continued capital investment that benefits the triple bottom line.
With that, Racho, please open the lines for Q&A.
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raised guidance for 2021 adjusted earnings to $2.83 - $2.87 per share.
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CNA performed extremely well in the third quarter with core income up 23% year-over-year despite the elevated catastrophe activity.
In the third quarter, core income was $237 million or $0.87 per share, driven by improved underlying underwriting performance and favorable Life & Group results.
Net income for the quarter was $256 million or $0.94 per share.
Gross written premium, excluding our captive business grew by 10% this quarter, fueled by excellent new business growth and continued strong price increases.
And importantly, momentum continued to build throughout the quarter.
As we expected, the transactional capability limitation that we mentioned last quarter, following the cyber security incident are now behind us.
Earned rate was 11% in the quarter, and written rate was 8%, which remains well above loss cost trends and which we believe portends continued progress toward building margin as the written premium earns in over a third renewal cycle in 2022.
Additionally, the tighter terms and conditions we have been able to secure during the hard market persists with no early signs of pressure to relax them.
I'll have more to say about production performance in a moment.
The all-in combined ratio was 100% this quarter, about a point lower than the third quarter of 2020, which included elevated catastrophes in both periods.
In the third quarter of 2021, pre-tax catastrophe losses were $178 million or 9.2 points of the combined ratio, which included $114 million for Hurricane Ida.
The P&C underlying combined ratio was 91.1%, a 1.5 point improvement over last year's third quarter results.
This is a record low for the third consecutive quarter.
After adjusting for the impacts of COVID in last year's third quarter, the improvement in our underlying combined ratio is actually 2.1 points.
The underlying loss ratio in the third quarter of 2021 was 60.2%, which is down 0.3 points compared to the third quarter of 2020.
Excluding the impacts of COVID in the prior year quarter, the underlying loss ratio improved by 0.9 points, and the decrease reflects our prudent acknowledgment of margin improvement.
As I've mentioned before, we increased our loss cost trends about 2 points over the last couple of years and classes impacted by social inflation.
This quarter, we increased our loss cost trends in property lines about 2 points because of the supply chain shortages, which have increased the cost of material and labor and don't look like they will revert back lower anytime soon.
This change pushed up our overall P&C loss cost trends marginally, and are now above 5%.
During the third quarter, earned rates are running close to 11%.
So, earned rate is exceeding loss cost trend by about 6 points.
Applying that to a 60% loss ratio should portend about 3 points of improvement in the quarter.
We have reflected about 1 point of improvement in the underlying loss ratio in the third quarter.
We are going to continue to be prudent in terms of acknowledging margins since the courts are just starting to open up and the dockets are only starting to clear.
The underlying combined ratio for Specialty was 89.6%, a 0.9 point improvement compared to last year, entirely from an improvement in the underlying loss ratio, while the expense ratio was comparable to the third quarter of 2020.
The all-in combined ratio was 88.2%, a 1.3 point improvement compared to the third quarter of 2020.
The all-in combined ratio for Commercial was 111.6% including 18.6 points of Cat compared to 111.3% in last year's third quarter including 17 points of Cat.
The underlying combined ratio for Commercial was 92.5%, which is the lowest on record and it's 1.2 points lower compared to last year and 2.3 points lower, excluding the COVID frequency impacts that reduced the loss ratio in 2020.
The underlying loss ratio improved by 0.4 points, excluding the COVID frequency impacts last year, while the expense ratio improved by 2 points.
Incidentally, compared to the second quarter of 2021, the underlying loss ratio is higher simply because of the resulting mix change between property and casualty net earned premium due to the new property quota share treaty we purchased in June.
In ceding [Phonetic] an annual estimate of property earned premium to the reinsurers in June, it altered the underlying loss ratio with a higher casualty mix going forward.
The underlying combined ratio for international improved by four full points to a record low of 91%.
This reflects at 2.8 point improvement in the expense ratio and a 1.2 point improvement in the underlying loss ratio, which was 58.9% in the quarter.
Importantly, as our reunderwriting has largely been completed in international, we've continued to see that benefit in the underlying loss ratio as well as a more modest catastrophe ratio from the meaningful reduction in our P&L exposures.
The all-in combined ratio of 95.5% compared to 98.1% in the third quarter of 2020, reflects the success of our reunderwriting strategy.
Now, turning back to production statistics.
As indicated earlier, our P&C operations had 10% growth in gross written premiums ex-captive which was 2 points above what we achieved in the first half of 2021 and 1 point above full year 2020.
Our growth in the quarter was fueled by strong new business growth of 24% and written rate of 8%, while retention was stable at 81%.
Net written premium growth for P&C was plus 5% for the quarter, up 4 points over the first half of the year.
Our specialty gross written premium growth ex-captive was plus 10%, driven by excellent new business growth of 40%, concentrated in affinity programs and management liability in continued strong rate of 9%.
This is our fifth consecutive quarter of double-digit growth in specialty notwithstanding that our retention in the third quarter was down about 5 points to 80%.
In the quarter, we continued our reunderwriting of the healthcare portfolio and we non-renewed a portion of our hospital medical malpractice business, because we could not achieve our required returns even after the rate increases we secured to-date.
Non-renewing this segment also lowered the rate increase for specialty this quarter, because it was the segment achieving some of our highest rate increases in recent quarters.
But improving our profitability is always our first priority and walking away from this business was the right action to take.
In Commercial, our gross written premiums ex-captives grew 10% in the quarter, representing an 8 point improvement over the second quarter's growth.
As we mentioned last quarter, commercial was disproportionately impacted by the cyber incident, as the majority of the underwriters in the branches are in the commercial business unit.
And so we expected to see the biggest rebound in commercial, now that it's behind us.
And we did indeed see that this quarter.
Commercial new business growth grew by 21% in the quarter with all segments contributing and retention increased 3 points to 83% compared to last quarter and rates increased 6%.
Although rates moderated in certain segments like national accounts, where rate increases were lower by 3 points, we still achieved a very strong 13% increase in the quarter, which is well above loss cost trends.
Our middle market rates were lower by 1 point this quarter, but we had a 7 point increase in retention to 84%.
We also achieved 2 points of exposure increase in Commercial in the quarter from higher payroll and sales compared to the third quarter of 2020.
Our international gross written premium growth was 16% for the quarter or 11% excluding currency fluctuation.
As we mentioned, with the reunderwriting actions behind us, we are focusing on growing the portfolio.
We continue to achieve strong rate in International at 13%, consistent with the second quarter.
Retentions have improved each quarter this year and stand at 79% in the quarter, up from 77% last quarter and 74% in the first quarter.
For P&C overall, prior period development was favorable by 0.3 points on the combined ratio.
Turning to Life & Group, we conducted our Annual Gross Premium valuation or GPV analysis on our active life reserves as well as a claim reserve review on our disabled life reserves.
There was no result in unlocking of the assumptions, which we believe is due to our continued prudent management of this run-off book and we now have $72 million of GAAP margin on the active life reserves.
The claim reserve review resulted in favorable development of $40 million on a pre-tax basis and Larry will have more detail on the Life & Group reserve analysis and our P&C prior period development.
Larry, of course, is no stranger to CNA.
He retired as CNA's Chief Actuary in August of last year after serving over a decade at CNA's Chief Actuary, during which time he worked hand-in-hand with the finance function.
Larry's willingness to come out of retirement has afforded us the time to accomplish a thorough search for this vital role which is going well and we expect to complete it soon.
Larry will also help facilitate a smooth transition with the incoming CFO.
I must say, it has been both a professional and personal pleasure working with the CNA executive team once again these past two months.
As Dino highlighted, the 23% increase in core income for the third quarter produced a core ROE of 7.7%.
Before providing more information on the financials, I will first discuss Life & Group.
As you know, each quarter -- each year in the third quarter, we complete our annual reserve reviews for Life & Group.
These reviews include our long-term care active life reserves, which we refer to as gross premium valuation or GPV as well as our long-term care and structured settlements claim reserves.
Slide 12 contains key demographic information about both our individual and group long-term care blocks.
As a reminder, both blocks are closed with no new policies issued for individual since 2004, and no new group certificates since 2016.
As a result, the average attained age for the individual block is 80 years old and the group block is 67.
While, the group block is less mature in age, you can see from the table on the top right of Slide 12 that the benefit features on average for the group block are less rich.
As we have discussed on past calls, we have proactively reduced risk in both blocks, while obtaining meaningful rate increases and using a prudent approach to setting assumptions in our reserve analysis, both for active life and claim reserves.
One clear result of our efforts is the 35% reduction in policy count since 2015, which is shown on the bottom left graph on Slide 12.
As we continue to push for needed rate, we also offer benefit reduction options to our policyholders as a means to avoid or mitigate rate increases.
This reduces the cost of future claims, while providing a viable option for our policyholders.
Also worth noting on Slide 12, our claim counts are down significantly over the past two years as can be seen in the graph on the bottom right.
Starting with the GPV analysis, the results of which are shown on Slide 13.
Our efforts involved a thorough review of all of our reserving assumptions, including critical factors related to morbidity, persistency, rate increases and discount rate.
The key result is that we did not have an unlocking event, and we now have margin in our GAAP carried reserves of $72 million.
Starting with the discount rate.
Recall, that last year we moved meaningfully on our assumption by lowering the normative risk free rate of 2.75% and increasing the gradient period for the risk free rate to rise to that level to ten years.
For the first three years of that 10-year period, as you might recall from last year's analysis, we used the forward curve.
We followed the same approach this year and the current forward curve has interest rates that are higher than the assumptions we locked in last year creating margin.
Given the higher rate interest rate environment, we also reviewed our estimates around the cost of care assumptions, and determined a small increase was warranted, which decreased margin.
Taken together, the changes resulted in creating the $65 million of margin disclosed in the table.
Turning next to Morbidity.
We refined our claim severity assumptions, specifically those related to utilization rates in our group block, expected recovery rates and claim side as mixed, which together drove margin improvement of $205 million.
Importantly, we did not include our favorable experience in 2020 due to COVID-19 as part of the datasets that are analyzed to update the long-term assumptions.
Not including the 2020 experience is further evidence of the prudent approach we take with our reserving assumptions.
With respect to persistency, the key assumption change was a decrease in healthy life mortality.
While, this result may seem counterintuitive as the pandemic caused elevated mortality, we excluded the impacts from the pandemic when setting our long-term GPV assumptions as we do not believe this recent elevated mortality will persist over the duration of our liabilities.
Rather, the assumption change is from a periodic review of past policy terminations to better determine our attribution between mortality and lapse.
For this year's review, we used external data sources to obtain data at a more granular level to examine the terminations over multiple past years.
The result of that effort was a slightly lower level of mortality than we had used in the 2020 assumptions.
Of course, even a slight change in mortality rate applied against the entire tail of the portfolio will have a leveraged effect and these assumption changes resulted in margin deterioration of $233 million.
We will continue to monitor active life mortality, relative to our revised assumptions to see how our approach plays out.
Regarding future premium rate increases, our actual rate achievement over the past year exceeded our assumption in last year's analysis, contributing $27 million to the favorable margin increase.
As you may recall, our prudent approach is to include rate increases that have been approved; filed, but not yet approved, or that we plan to file as part of a current rate increase program.
As a result, the weighted average duration of future rate increase approvals assumed in reserves is less than two years.
As you can see on Slide 13, the cumulative impact of these changes, including a slight margin improvement of $8 million from lowered operating expenses, resulted in a reserve margin of $72 million in our carried reserves, while continuing to use a prudent set of reserve assumptions.
As a result, there is no need to have an unlocking event and we feel good about the reserves.
In addition to the GPV, we concluded our annual long-term care claims reserve review, which is a review of the sufficiency of our reserves for current claims.
The impact from this review was favorable, driven by lower than expected claims severity.
Specifically, we observed higher claim closure rates, most notably driven by mortalities.
The favorability, which flows through to our bottom line was a pre-tax benefit of $41 million -- $40 million or $31 million on an after-tax basis.
Turning to Slide 14.
Our overall Life & Group segment produced core income of $41 million in the third quarter, which compares to a third quarter 2020 loss of $35 million.
In addition to the $31 million favorable impact from the annual long-term -- long-term care claims review that I just discussed, activity in the quarter contributed another $10 million to core income, as we had strong net investment income performance predominantly from our alternative investments portfolio.
Returning now to financial results, our third quarter 2021 pre-tax underlying underwriting profits increased 28% on a year-over-year basis, driven by the 6% growth in net written premium and a record low underlying combined ratio.
A key component of the combined ratio improvement is the expense ratio.
The third quarter 2021 expense ratio of 30.7% was 1.1 points lower than last year's third quarter.
Our Commercial and International segments drove the overall improvement, as commercial improved 1.9 points to 30.4% and International improved 2.8 points to 32.1%.
Our focus on expense discipline as we grow the Company has driven meaningful expense improvement.
And this quarter's result reinforces the success of our strategy.
Of course, as we have mentioned before, the improvement will not be a straight line down because, we continue to make investments in talent, technology and analytics, which in any one period can materially vary.
As this quarter's expense ratio reflected somewhat less investment, we believe a more appropriate expectation on run rate is 31%.
For the third quarter, overall P&C net prior period development impact on the combined ratio was 0.3 points favorable, compared to 0.4 points favorable in the prior year quarter.
Favorable development was driven by surety in the specialty segment, somewhat offset by amortization of workers' comp tabular reserves in the commercial segment.
In terms of our COVID reserves, we made no changes to our COVID catastrophe loss estimate following an in-depth review during the quarter, and our loss estimate is still virtually all in IBNR.
Total pre-tax net investment income was $513 million in the third quarter compared with $517 million in the prior year quarter.
The results included income of $77 million from our limited partnership in common stock portfolios as compared to $71 million on these investments from the prior year quarter.
The strong LP returns for the quarter across both the P&C and Life and Group segments were significantly driven by private equity investments and reflected the lag reporting results from the second quarter.
As a reminder, our private equity funds primarily report results on a three-month lag basis, whereas our hedge funds primarily report results on a real-time basis.
Our fixed income portfolio continues to provide consistent net investment income, stable relative to the last few quarters and modestly down relative to the prior year quarter.
The year-over-year decrease reflects lower reinvestment yields due to the ongoing low interest rate environment with pre-tax effective yields on our fixed income holdings of 4.3% during the third quarter of 2021, compared to 4.5% during the third quarter of 2020.
However, our strong operating cash flows have fueled the higher investment base with the book value of the fixed income portfolio growing by $1.5 billion over the past year.
From a balance sheet perspective, the unrealized gain position of our fixed income portfolio was $4.8 billion at quarter-end, down from $5.1 billion at the end of the second quarter, reflecting a slightly higher interest rate environment.
Fixed income invested assets that support our P&C liabilities and Life & Group liabilities had effective duration of 5.1 years and 9.3 years respectively at quarter-end.
Our balance sheet continues to be very solid.
At quarter-end, shareholders' equity was $12.7 billion or $46.67 per share.
Shareholders' equity excluding accumulated other comprehensive income was $12.3 billion or $45.39 per share, an increase of 8% from year-end 2020 adjusting for dividends.
We have a conservative capital structure with a leverage ratio of 18% and continue to maintain capital above target levels in support of our ratings.
In the third quarter, operating cash flow was strong once again at $669 million.
In our P&C segments, the paid to incurred ratio was 0.75%, consistent with the last two quarters.
Contributors to this include our growth, which increases the incurred losses while paid losses lagged, especially for casualty lines, as well as the ongoing impact of slowed court dockets.
Certainly, the occurrence of catastrophe events in a given quarter and the payout over subsequent quarters impact this ratio as well.
In addition to strong operating cash flow, we continue to maintain liquidity in the form of cash and short-term investments and together they provide ample liquidity to meet obligations and withstand significant business variability.
Finally, we are pleased to announce our regular quarterly dividend of $0.38 per share.
Before opening the call for the Q&A session, I'd like to offer a few comments about how we see the marketplace that we compete in evolving.
Most importantly, we see the market remaining very favorable throughout 2022.
We continue to build momentum in new business growth and retention, and rate increases should remain above long-run loss cost trends for most of 2022 in light of the headwinds of social inflation, elevated Cat activity, low interest rates and the additional headwind of economic inflation emanating from the protracted supply chain dynamics.
Although rates have moderated from the high watermark of the fourth quarter of last year, it is premature to assume it will continue down on a straight line due to the uncertainty of the strength of the headwinds.
In the third quarter, we saw pricing inflections as a response to pressure on those headwinds.
As an example, momentum on cat exposed property pricing picked up immediately after Hurricane Ida.
And the supply chain issues creating higher cost of labor and materials are partially offsetting the benefit of the price increases, leading to a greater awareness that additional rate is required in property for a longer period of time.
Similarly, notices of seemingly outsized jury awards in the industry reminds us that social inflation was merely obfuscated during the pandemic, and by no means extinguished, which should allow continued strong pricing in most casualty lines.
Indeed, we are seeing similar strength in our price increases early in the fourth quarter.
Bottom line, we believe written rate increases will persist above loss cost trends in 2022 leading to earned rates above loss cost trends for a third year in a row, which portends well for margin build all else equal.
And we remain very bullish about our ability to increasingly take advantage of the opportunities this continuing favorable marketplace affords us.
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compname announces third quarter 2021 net income of $0.94 per share and core income of $0.87 per share.
q3 core earnings per share $0.87.
q3 earnings per share $0.94.
qtrly book value per share of $46.67.
qtrly book value per share excluding aoci of $45.39.
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I am pleased to share our fourth quarter results and our full-year performance in what was clearly an unprecedented year.
Importantly, our industry rose to meet the challenges and effectively deliver on our commitments.
I'm very proud of our CNA employees who effectively served the needs of our agents and brokers, as well as our insurers, and have positioned us well to continue to take advantage of the hardening market conditions.
Before I provide detail on the quarter, here are a few highlights for the full-year.
Core income was $735 million, or $2.70 per share, and net income for the year was $690 million, or $2.53 per share.
This compares to $979 million and $1 billion in 2019, respectively.
The shortfall from the prior year primarily attributed to the impact of the elevated pre-tax catastrophe losses of $550 million, which included our reserve charge for the pandemic of $195 million that we announced in the second quarter of 2020 as compared to $179 million of catastrophe losses in 2019.
On the other hand, our P&C underlying underwriting profit for the full-year increased 38% to $498 million as the underlying combined ratio improved 1.7 points to 93.1%.
It is the fourth consecutive year of improvement in the underlying combined ratio.
The improvement in the underlying combined ratio came from both the loss ratio and the expense ratio.
Our underlying loss ratio improved 0.8 points from 2019.
A half a point of the improvement reflected the favorable claim frequency from the shelter-in-place directives.
The frequency benefit was relatively muted for us because, as I said on the second quarter call, a substantial portion of our insureds are in essential industries, such as healthcare, construction and manufacturing, which were not subject to shelter-in-place restrictions.
The expense ratio improved 0.9 points from 2019 to 32.6%, which reflected our disciplined approach to managing expenses as we grow the business and continue to make meaningful investments in talent, technology and analytics.
The all-in combined ratio was 100.9% with 7.7 points of catastrophe losses and flat prior period development.
Gross written premium growth ex-captives grew 9% in 2020 despite the impacts of the economic downturn, which reduced our exposure almost 3 points from the prior year.
Net written premium increased 6% for the full-year.
We successfully achieved rate increases of 11% for the full-year, more than double our 2019 rate increases, and new business was up 6% for the year.
We continue to leverage this hardening market to build margin, all else equal, as rates continue to earn-out above our long run loss cost trends.
The 11% of written rate we achieved in 2020 was 8 points on an earned basis for the full-year, while our long run loss cost trends were about 4 points.
However, as I have said before, we are going to continue to be prudent on how we act on any margin due to the global pandemic's disruptive impact obfuscating claim trends [Phonetic], in particular social inflation.
Moreover, the economy has not recovered nor have court dockets reverted to pre-pandemic activity, therefore, we are staying the course.
Turning to the fourth quarter.
Our results in the quarter evidenced our strong execution in every aspect of our business, including significant growth driven by double-digit rate, strong new business growth, and improved retention, as well as an improved underlying loss ratio and expense ratio.
We also benefited from a low catastrophe quarter and strong investment performance.
Core income for the quarter was a record $335 million, $1.23 per share, an increase of $70 million over the prior year fourth quarter.
The increase was largely driven by improved underlying underwriting profits.
Net income for the quarter was $387 million, or $1.42 per share, and was an increase of $114 million over 2019's fourth quarter.
The P&C underlying combined ratio was 92.7%, a significant improvement over last year's fourth quarter results and in line with Q3 results, both of which are the best two underlying combined ratios CNA has had in over 10 years.
The all-in combined ratio was 93.5%, slightly more than 2 points of improvement compared to the fourth quarter a year ago, driven by commercial, which improved 4.4 points to 96.2% and international, which improved 3.4 points to 96.9%.
Although specialty had less favorable prior period development in the fourth quarter a year ago, they had a very strong combined ratio of 89.4%.
Pre-tax catastrophe losses were benign at $14 million, or 0.8 points of the combined ratio.
Our estimated ultimate losses from COVID-19 are unchanged at $195 million as claim activity continues to unfold slowly, as we expected.
Prior period development had no impact on the combined ratio in the quarter.
The underlying loss ratio was 60.5% for the quarter, a 0.4 point year-over-year improvement and consistent with Q3.
Specialty was 60%, commercial was 61.1%, and international was 60.1%.
In the fourth quarter, the expense ratio was 32%, 1.7 points better than the prior year quarter as we maintained a disciplined approach to managing expenses as we continue to grow the business.
We are pleased with the improvement and as our growth continues to earn out through 2021, we expect that to drive additional improvement.
Gross written premium ex our captive business grew 15% in the quarter with significant contributions across all operating segments, with specialty at plus 17% and commercial at plus 13%.
International was also strong at plus 14%, fueled by strong rate in the quarter in our London operation and strong rate and new business growth in our Canadian operations.
Net written premium for total P&C increased 12% in the quarter.
In the quarter, the hardening market persisted as evidenced by our continued double-digit rate achievement of plus 12%, while increasing our retention by 3 points to 85% from the third quarter.
We achieved strong rate across the board with specialty at plus 13%, commercial at plus 12%, and international at plus 18%.
In addition to double-digit rate achievement for the quarter, we continued to implement tighter terms and conditions across our portfolio.
These improved terms and conditions, as I have mentioned before, are equally important to strong pricing as they improve attritional loss ratios, help prevent unintended coverage, and are typically slower to be relaxed once market conditions start to soften.
New business growth was strong in the quarter, 17% higher compared to last year's fourth quarter.
Specialty grew 23% and commercial 22%, while international remained slightly negative.
We are writing high-quality accounts within our target market segments.
Examples, we continue to grow our profitable specialty affinity portfolio, we grew our very profitable construction segment within commercial, and we are building our management liability portfolio at a time when we can get excellent terms and conditions.
We carefully monitor pricing on new business relative to renewal policies, and the new to renewal relativities have been stable all year across the portfolio, indicating rate on new business has increased commensurately and obviously contributed to the overall growth in new business.
We are well positioned to grow in these hardening market conditions and indeed, we believe it is the best time to grow.
In addition to restoring pricing to these levels and improving terms and conditions, the disruption from insured dislocation in a hardening market causes broad remarketing by agents and brokers that also ferrets out tremendous high-quality new business opportunities, and we have been able to secure more of these opportunities as we are leveraging all the investments we have made in the last few years to deepen our specialized underwriting expertise and provide improved solutions to our customers.
Finally, we completed our annual asbestos and pollution reserve review, which resulted in a non-economic after-tax charge of $39 million, which compares to last year's after-tax charge of $48 million, and we also had positive core income of $26 million from our life and group operations.
Al will provide more detail on this, as well as our asbestos and pollution review.
As Dino mentioned, I will provide more detail on the Life & Group results, as well as our corporate segment, including the asbestos, environmental reserve review.
Before I do that, let me just highlight a few items related to our overall results, as well as our P&C operations.
Core income for the quarter was a record at $335 million, 26% higher than the prior year quarter results.
With a core ROE of 11.4% for the period, we are certainly pleased with the close to 2020 and the significant progress made to build upon our underlying underwriting profitability.
Dino spoke about this progress with regards to our combined ratio improvement.
A meaningful contributor was the expense ratio.
I would like to highlight the advancements made during 2020.
Our fourth quarter expense ratio of 32% reflects significant progress on a year-over-year basis, as well as on a sequential quarter basis during 2020.
The expense ratio improvement was reflected in all three of our P&C business segments, especially in international notably recording improvements of 2 and 3 points, respectively, versus the prior year quarter.
We are particularly pleased with the international results as the efforts to reduce acquisition costs as part of our reunderwriting strategy is paying dividends.
Likewise, with respect to specialty and commercial, the significant progress we have made on our expense ratio reflects our ability to grow while being disciplined about our expense spend and also making investments back into the business.
Considering the trajectory of our net written premium, we would expect that our earned premium growth will further aid our progress on the expense ratio in 2021.
Turning to net prior period development and reserves, for the fourth quarter overall P&C net prior period development was flat compared to 2.2 points of favorable development in Q4 2019.
Favorable development in specialty during the quarter driven by professional and management liability was offset by adverse premium development on general liability within commercial.
For the full-year 2020, overall development was essentially flat versus 0.7 points of favorable development in 2019.
In terms of our COVID reserves, we have made no changes to our catastrophe loss estimates during the quarter.
We continually review our COVID reserves and our previously established estimate of ultimate loss remains appropriate, and our loss estimate is still virtually all in IBNR.
Finally, with regards to the P&C operations, on January 1 several of our reinsurance treaties were renewed, the main ones being for management liability and casualty lines of business.
These treaties renewed with more favorable terms and conditions relative to expectations given current market conditions.
Now, turning to Life & Group.
This segment produced core income of $26 million in the quarter and $9 million for the full-year.
This compares with Q4 2019 loss of $4 million and a full-year 2019 loss of $109 million.
Favorable long-term care results for full-year 2020 relative to 2019 reflects the lower reserve charge in the current year relative to the prior year, as well as better-than-expected morbidity experienced in 2020 amid the effects of COVID-19.
Specifically, since the onset of COVID, we've experienced lower-than-usual new claim frequency, higher claim termination, and more favorable claim severity as policyholders favor home healthcare versus the use of long-term care facilities.
The higher level of claim terminations is largely being driven by an elevated level of mortality and claimant recoveries.
As referenced in the previous quarters, given the uncertainty of these trends, we've been taking a cautious approach from an income recognition perspective, and accordingly, we've been holding a higher level of IBNR reserves.
As well, in our annual gross premium valuation review completed in third quarter of 2020, we did not build any of this favorable experience into our ongoing reserving assumptions.
With all of this in mind, we are closely evaluating these favorable claim trends to assess the extent to which they may persist beyond the pandemic.
Our Corporate segment produced a core loss of $60 million in the fourth quarter and $108 million for the full-year.
This compares to a $68 million loss in Q4 2019 and $102 million loss for the full-year 2019.
The loss for Q4 2020 was driven by our annual asbestos, environmental reserve review concluded during the quarter.
The results of the review included a non-economic after-tax charge of $39 million driven by the strengthening of reserves associated with higher defense and indemnity costs on existing claims, and this compares to last year's non-economic charge of $48 million.
Following this review, we have incurred cumulative losses of $3.3 billion, well within the $4 billion limit of our loss portfolio transfer cover that we purchased in 2010, and paid losses are now at $2.1 billion.
You will recall from previous years' reviews that while we continue to be covered under this OPT limit, there is a timing difference with respect to recognizing the benefit of the cover relative to incurred losses as we can only do so in proportion to the paid losses recovered under the treaty.
As such, the loss recognized today will be recaptured over time through the amortization of the deferred accounting gain as paid losses ultimately catch up with incurred losses.
As previously announced, we've entered into a loss portfolio transfer transaction with a subsidiary of Enstar Corporation and related to legacy excess worker comp reserves.
This non-core portfolio has been in runoff for over 10 years and the transaction enables us to strengthen our focus on going forward operations while reducing potential future reserve volatility.
The transaction closed on February 5.
Going forward, we'll report the impacts associated with this line of business and the associated loss portfolio transfer through the Corporate segment.
Turning now to investments.
Pre-tax net investment income was $555 million in the fourth quarter, compared with $545 million in the prior year quarter.
The results reflected more favorable returns from our limited partnership and common equity portfolios relative to the prior year, more than offsetting the decline in net investment income from our fixed income portfolio and attributable to lower reinvestment yields.
As a point of reference, pre-tax effective yield on our fixed income holdings was 4.4% at Q4 2020 compared to 4.7% as of Q4 2019.
Pre-tax net investment income for the full-year was $1.9 billion, compared with $2.1 billion in the prior year.
While lower interest rates have certainly been a headwind for our net investment income, it's also driven the increase of our unrealized gain position on our fixed income portfolio, which stood at $5.7 billion at year end, up from $5 billion at the end of the third quarter and $4.1 billion at the end of 2019.
The change in unrealized during the quarter was driven by the tightening of credit spreads across the market, our risk-free rates have remained low.
Fixed income invested assets that support our P&C liabilities had an effective duration of 4.5 years at quarter end.
The effective duration of the fixed income assets that support our Life & Group liabilities was 9.2 years at quarter end.
Our balance sheet continues to be very solid.
At quarter end, shareholders' equity was $12.7 billion, or $46.82 per share, reflective of the increase in our unrealized gain position during the quarter.
Shareholders' equity excluding accumulated other comprehensive income was $11.9 billion, or $43.86 per share.
Book value per share ex-AOCI and excluding the impact of dividends paid has grown by 6% over the last year.
We have a conservative capital structure with a leverage ratio below 18% and continue to maintain capital above target levels in support of our ratings.
In the fourth quarter, operating cash flow was strong at $367 million, compared to $160 million during Q4 2019.
On a full-year basis, operating cash flow was $1.8 billion versus $1.1 billion for 2019, a significant increase substantially driven by the improvement in our current accident year underwriting profitability and a lower level of paid losses.
In addition to our strong operating cash flow, we continue to maintain liquidity in the form of cash and short-term investments and have sufficient liquidity to meet obligations and withstand significant business variability.
Finally, we are pleased to announce an increase in our regular quarterly dividend to $0.38.
This increase reflects our confidence that we can continue to grow our underwriting profits and build upon our financial strength.
In addition, notwithstanding an extraordinary year in 2020, including the elevated impact of catastrophe on our results, we were pleased to declare a special dividend of $0.75 per share.
In summary, we had a great quarter generating record core income as we effectively leveraged the opportunities from the hardening market, as we did throughout the year, and we are confident in our ability to continue to do so as these market conditions persist in 2021.
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compname posts q4 earnings per share $1.42.
compname announces q4 2020 net income of $1.42 per share and core income of $1.23 per share.
compname announces full year 2020 net income of $2.53 per share and core income of $2.70 per share.
q4 core earnings per share $1.23.
q4 earnings per share $1.42.
book value per share $46.82 at december 31, 2020 versus $45.00 at december 31, 2019.
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Such risk factors are set forth in the company's SEC filings.
We appreciate you joining us to discuss our 2021 third quarter results.
I'm very pleased to start off by saying that our industry and our company continue to make significant progress in recovering from the effects of the pandemic.
We're highly encouraged by the continuing positive trends with increasing consumer demand for the cinematic theatrical experience and growing momentum at the box office.
This favorable progress was demonstrated in our third quarter's 61% growth in worldwide attendance since last quarter in 2Q '21.
Importantly, that growth in attendance flowed through to our bottom line results in the third quarter, which included positive adjusted EBITDA of $44 million.
Our 3Q results marked a significant milestone for Cinemark as it represents our first quarter since the pandemic began with positive total company adjusted EBITDA.
Furthermore, every month in 3Q delivered positive EBITDA, which tangibly underscores our company's resurgence.
Strength in the domestic box office was a key driver of our third quarter performance, as the North America industry delivered $1.4 billion of gross proceeds on a larger volume of more sizable commercial releases.
Top hits in the quarter included Shang-Chi and the Legend of the Ten Rings, Black Widow, Jungle Cruise, Free Guy, Space Jam and the carryover from 2Q's highly successful release of Fast and Furious Nine.
And consistent with last quarter, I'm thrilled to report that Cinemark once again over-indexed the North America industry box office performance relative to 3Q '19 with a substantial outperformance of 700 basis points.
This outperformance helped us capture an approximate 15% market share of North America box office, which significantly exceeded our historic average of just under 13%.
Our 15% market share achievement is particularly meaningful this quarter as the vast majority of theaters in the U.S. and Canada had reopened.
During our last several calls, we talked about four key factors that impact theatrical exhibition recovery, all of which continue to experience noteworthy progress.
First, is the status of the virus.
Driven by vaccine penetration to date as well as impacts from the virus beginning to subside, COVID rates have plunged 73% since the Delta variant peaked in September.
Vaccination rates continue to rise across the U.S., especially with the recent approval of inoculation for children five and older.
Moreover, vaccination rates are also rapidly progressing throughout Latin America.
The second factor is government restrictions, which have largely gone away in the U.S. at this juncture and continue to reduce in Latin America.
Third is consumer sentiment.
While the Delta variant threw us a curve ball during the third quarter and caused a meaningful dip in consumer comfort regarding visiting theaters, that sentiment has since recovered to 77% of U.S. moviegoers expressing comfort and going to the theater in the current environment.
This level of positive response is in line with the peak levels of sentiment we witnessed in early July of 78%.
And the final key factor of the theatrical exhibition recovery is the consistent flow of new film content with broad consumer appeal, which clearly is now underway.
Of course, these recovery factors not only apply to the U.S., but are also applicable on a global basis.
And while the domestic market is further along in its rebound cycle, we're also seeing positive trends in Latin America.
Currently, 100% of our theaters have reopened across the region, and even though certain capacity and operating hour restrictions persist in Central and South America, consumer demand to return to the theaters is very strong.
There is no question that theatrical exhibition is meaningfully recovering around the world, and Cinemark is extremely well positioned to benefit during this comeback on account of the many operational advancements we made during the pandemic as well as our ongoing efforts to maximize attendance and drive new ancillary revenue opportunities.
Some examples include improved operating efficiencies, enhanced marketing programs and capabilities and our recently implemented online food and beverage platform, new alternative content possibilities and ongoing impact of our premium amenities.
In terms of operational efficiencies, we have made some significant strides over the course of the pandemic.
For instance, we're optimizing operating hours and showtime schedules through utilization of enhanced data management analytics.
We have simplified and streamlined numerous theater practices, such as ticket issuance, inventory procedures and ushering routines to be leaner and more efficient.
And we've refined the degree of staffing that is required to operate our theaters, including enhanced planning and management controls.
We also continue to significantly advance our digital and social marketing capabilities, utilizing proven best practices from retail, travel and technology industries.
Examples include leveraging iterative A/B testing to identify and scale winning concepts, simplifying consumer touch points to drive a more frictionless experience and applying advanced analytics against our highly valuable customer database to drive improved targeting accuracy and contextually relevant messaging.
These actions and capabilities are focused on increasing moviegoing frequency and overall consumer spend, and we believe they will be highly valuable in navigating the competitive landscape ahead and maintaining our increased market share.
In tandem with our digital and social marketing actions, we continue to leverage our unique industry-leading transaction-based subscription program, Movie Club, to drive attendance.
During the third quarter, we completed billing reactivation on all Movie Club accounts that were proactively paused for the past 1.5 years during the pandemic.
In doing so, we have been extremely pleased by the minimal amount of churn we've experienced, which represented only a modest 6% dip in our pre-pandemic membership base that was largely driven by credit cards that expired during that timeframe.
This dip was better than expected due to our member-first approach, and we're already seeing new net positive Movie Club additions as we actively work to reattain those expired members as well as attract new ones.
We've also continued to further enhance Movie Club and recently introduced Movie Club Platinum, an earned premium tier that provides our most frequent moviegoers with even bigger incentives.
We expect this heightened tier will serve to further increase loyalty of our most active customers as well as stimulate incremental transactions.
Since we announced the launch of Movie Club Platinum just over a month ago, 64% of Movie Club members familiar with the program stated that they have been incentivized to achieve Platinum status this year.
Another foray into simplifying and enhancing our customer experience while driving ancillary revenues is Snacks In A Tap, our recently launched online food and beverage ordering platform.
This platform enables guests to skip the line and have their concessions ready for pickup upon arrival or delivered to their seats for a nominal fee.
The added convenience and time savings provided by Snacks In A Tap have been extremely well received by our moviegoers, and we look forward to continuing to grow the program's awareness and utilization in the months ahead.
We're also continuing our reintroduction of select expanded food and beverage options as a more consistent release cadence of stronger film content takes hold and moviegoer attendance increases.
Another exciting new business venture that we announced last week is our heightened focus on gaming initiatives, including our plan to hire a new Vice President to forge strategic relationships and pursue content and licensing agreements in the gaming realm.
Gaming is the latest evolution in our ongoing focus to secure alternative content, further utilizing our auditoriums to supplement Hollywood film content, and we have seen several promising indicators with regards to consumer interest in both spectator and participatory gaming events.
Additionally, we're continuing to explore other alternative content offerings and have seen similar positive results from events such as professional wrestling with AEW and WWE, boxing with Triller Fight Club, movie premiers, special live Q&A sessions with talent and concerts, all in addition to ongoing events provided by Fathom entertainment.
We're also continuing to reap benefits from investments we've made in premium amenities that enrich the moviegoing experience, which movie fans continue to seek out, including reclining seats with approximately 65% of our entire domestic circuit featuring country loungers, the highest recliner penetration among the major theater operators.
Premium large-format auditoriums led by our XD, our proprietary brand, which ranks number one in the world, which delivered 12% of our box office in the third quarter alone on only 4% of our screens and an increase in D-Box motion seats, which are synchronized with the on-screen action.
And finally, Cinionic laser projectors.
In line with our previously announced partnership, we are featuring laser projections crystal clear picture in all of our new build theaters and continue to upgrade our existing theaters with laser technology, which lasts longer and operates more efficiently.
We're happy to share that in addition to other locations across the U.S., we have completely converted all of our Dallas-Fort Worth theaters and screens, our home city, delivering consistently bright, colorful and sharp images on laser.
Speaking of new theaters, strategic new-builds are a cornerstone of our strategy, and we are thrilled to have opened six new theaters and 67 screens already this year, all of which were committed to prior to the onset of COVID.
These new-build theaters are all in high-growth areas with significant opportunities to capture moviegoing attendance.
While it's still early days, we're highly encouraged by the results to date.
We have opened three locations in the U.S., Kirkland, Washington, just outside of Seattle; Jacksonville, Florida; Waco, Texas; and three in Latin America, Guatemala, Chile and Peru.
We also have one more theater open -- to open later this year in Roseville, California, just outside of Sacramento.
Based on everything I've just shared, I hope it's clear that we are pleased with our performance trend in the third quarter and the advancements we made to continue to make our business more vibrant through business development.
While we're cognizant, there's still a long road ahead.
Over the course of the coming months, we continue to expect an ongoing ramp-up of box office and overall financial results.
The fourth quarter has already started out strong as October delivered our best monthly box office results since the onset of COVID.
Notably, our cash generation during the month of October was significant enough to more than cover all of our variable and all of our fixed costs.
Looking ahead, upcoming film content for the balance of the year includes highly anticipated blockbusters appealing to families and adults alike, such as Eternals, which opened with previews last night to outstanding results.
Ghostbusters: Afterlife, Encanto, House of Gucci, West Side Story, Spider-Man: No Way Home, Matrix: Resurrection and Sing two to highlight just a few.
And the slate next year looks absolutely tremendous with broad range of highly promising films for all moviegoing audiences.
Importantly, these films were made to be experienced in a cinematic out-of-home entertainment environment that only a movie theater can provide.
We're also optimistic about the future of exclusive theatrical windows as it's such a meaningful contributor to the overall media landscape.
As we've witnessed with the positive box office results generated most recently, I have been a significant proponent of the longevity of the theatrical exhibition industry, and especially for Cinemark, as the company is uniquely positioned and poised for long-term success.
As previously announced, this is my last earnings call as CEO of Cinemark before I hand over the reins to Sean at the end of this year.
It has been an honor serving as CEO and leading the incredible people of Cinemark the past 6.5 years.
It has been tremendous getting to know so many of you over the years, and we appreciate your ongoing support.
I, along with the rest of the Board, are highly confident in Sean and his ability to lead Cinemark going forward.
His operational background and strategic mindset along with his keen eye for efficiencies and business opportunities will be especially advantageous as Cinemark continues to emerge from the effects of the pandemic.
I look forward to watching the company thrive under his direction as I continue in a strategic capacity through my position on the Board.
You've been a tremendous leader for our company and our industry over the past 6.5 years.
And to say you'll be missed from our day-to-day operations is clearly an understatement.
On a related note, three weeks ago, we announced Melissa Thomas will be joining Cinemark as our next CFO.
Melissa was most recently the CFO for Groupon and has a strong and impressive leadership and financial background.
We believe she will be a great cultural fit for Cinemark and an excellent complement to our leadership team and finance organization.
Melissa will officially start this coming Monday, November 8, and we look forward to formally introducing her in the near future.
As Mark already highlighted, the resurgence of theatrical moviegoing is in full swing, and Cinemark delivered another quarter of meaningful financial improvement.
During 3Q, our average monthly cash burn reduced to approximately $11 million after normalizing for working capital timing.
This rate was in line with the expectation of a $10 million to $15 million monthly cash burn that we communicated on our last earnings call.
As of today's current operating environment, we have now flipped to modestly positive average monthly cash flow, and we expect this rate will continue to improve as our industry further rebounds.
At the end of the third quarter, we had a global cash balance of $543 million.
As of October 31, that balance had increased to approximately $595 million, driven by the strong box office results of Venom: Let There Be Carnage, No Time To Die, Halloween Kills and Dune as well as working capital timing associated with corresponding film rental payments.
Based on our current and improving cash flow position, we continue to believe we have ample liquidity and will not require any additional financing.
That said, multiple financing opportunities still remain available to us, including drawing on our $100 million revolving credit line, tapping incremental term loan borrowing capacity within our credit facility, executing sale-leaseback arrangements on unencumbered properties we own and issuing equity.
Also, as we described last quarter, following our recent refinancing transactions, our revolver maturity now sits at November of 2024 and all other significant debt maturities extend through March of 2025 and beyond.
Turning now to our third quarter results.
Furthermore, as we have indicated in previous quarters since the onset of the pandemic, our traditional metrics continue to be somewhat distorted in the current environment.
Considering our theaters were only beginning to reopen with limited new film content in the third quarter of 2020, we will compare our most recent quarter's results to 2Q '21 and 3Q '19 in select instances.
During the course of the third quarter, we continued to further expand operating hours in response to increasing consumer demand for a growing volume of new commercial film releases.
Compared to second quarter, our third quarter domestic operating hours expanded by nearly 40%, although still remained approximately 25% below 3Q '19.
Expanded hours and increased moviegoing led to quarter-over-quarter domestic attendance growth of 42.4% to 21.5 million patrons.
Domestic admissions revenues were $195.3 million with an average ticket price of $9.08.
Our average ticket price increased 14.1% versus 3Q '19, primarily as a result of price increases and ticket type mix largely on account of fewer matinee and weekday showtimes.
Domestic concessions revenues were $142.6 million and yielded another all-time high food and beverage per cap of $6.63.
Our third quarter per cap was roughly flat with 2Q accrued 27% compared to 3Q '19 as pent-up moviegoing demand continues to drive a heightened indulgence in food and beverage consumption across our core concession categories and operating hours remain concentrated in timeframes that are more conducive to concession purchases.
Our third quarter results also benefited from ongoing strategic promotions and pricing initiatives, the reintroduction of various enhanced food offerings and recognition of previously deferred revenues associated with the issuance of loyalty points.
Domestic other revenues also continued to rebound during the quarter and grew 28.3% to $37.6 million, driven by volume-related increases in screen ads, transaction fees and promotional income.
Altogether, third quarter total domestic revenues were $375.5 million, with positive adjusted EBITDA of $44.8 million.
Internationally, we also continue to see material recovery in Latin American box office and operating results during the third quarter.
Driven by expanded theater openings and increased availability of new film -- new commercial film content, our third quarter international attendance grew 128% versus 2Q '21 to 9.2 million patrons, which generated $30.2 million of admissions revenues and $21.6 million in concession revenues.
Total international revenues were $59.3 million and yielded adjusted EBITDA that was just shy of breaking even for the quarter.
Globally, film rental and advertising expenses were 51.9% of admissions revenues, which increased 200 basis points compared to 2Q '21.
This increase was expected and resulted from a higher concentration of larger, more successful new film releases.
That said, compared to the third quarter of 2019, our film rental rate was still down 420 basis points, predominantly due to reduced film grosses as skew lower on our film rental scales.
Concession costs were 17.2% of concessions revenues and were in line with both our second quarter results and pre-COVID averages.
Third quarter global salaries and wages were $67.6 million and increased 34.1% versus 2Q '21.
This increase was driven by additional theater reopenings, extended operating hours to accommodate growing consumer demand and the reintroduction of select enhanced food and beverage options that require more labor.
Facility lease expenses were $68.8 million, and while largely fixed, experienced a modest uptick from the second quarter due to a slight increase in percentage rent in common area maintenance as volumes increased.
Worldwide utilities and other expenses were $81.8 million and increased 33.7% quarter-over-quarter, driven by variable costs that grew in line with volume, such as credit card fees, janitorial expenses and commissions paid to third-party ticket sellers.
Utility expenses also increased as we expanded operating hours while other costs within this category, such as property taxes and property and liability insurance remained predominantly fixed.
Finally, G&A for the quarter was $38.6 million and remained considerably lower than pre-pandemic levels as a result of the restructuring actions we pursued in the second quarter of 2020 and our ongoing efforts to minimize nonessential operating expenditures.
Collectively, our worldwide adjusted EBITDA for the third quarter was positive $44.3 million.
As Mark previously described, this result represents a significant milestone for our company as it was our first quarter of positive total company adjusted EBITDA since the onset of the pandemic and our second consecutive quarter of material adjusted EBITDA recovery.
Our net loss also materially improved in 3Q to $77.8 million, reducing by $64.7 million quarter-over-quarter.
We'd like to congratulate our studio partners on the success their films achieved in the quarter, and we like to commend our hard-working teams on their relentless execution and drive to deliver these results.
Capital expenditures during the quarter were $24.4 million, of which $13.6 million was associated with new-build projects that had been committed prior to the COVID-19 pandemic and $10.8 million was driven by investments and maintenance in our existing theaters.
Our consistent investment in proactively maintaining and enhancing our theaters over the years has enabled us to scale back capital expenditures in the near term without hindering our asset quality or guest satisfaction.
As such, we continue to anticipate spending a highly reduced level of capex in 2021 relative to pre-pandemic ranges, which we previously estimated at approximately $100 million.
However, due to varied supply chain constraints that have started impacting the delivery timing of certain equipment and supplies, we now anticipate capex may come in slightly below $100 million for the full year.
That said, we do not expect these delays will have any adverse impact on our daily operations.
In closing, we are thrilled with the positive momentum we continue to experience regarding the rebound of theatrical exhibition and our company's financial results, and we are optimistic about the robust release calendar that lies ahead in the fourth quarter and beyond as well as further improvements in consumer moviegoing enthusiasm as the pandemic subsides.
We are proud of the advancements our team has already made to set up Cinemark for success in a post-pandemic environment, and we look forward to the impact our strategic initiatives will continue to have on further enhancing the cinematic entertainment experience we provide our guests and delivering long-term shareholder value.
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expect a continued ramp-up in box office performance over course of coming months.
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Such risk factors are set forth in the company's SEC filings.
We appreciate you joining us for our fourth quarter and full year 2021 results.
It has been a pleasure getting to know many of you during my time as CFO and COO, and I look forward to our ongoing relationships in my new role.
The theatrical exhibition industry made huge strides in its recovery throughout 2021, culminating in an exceptional fourth quarter, during which North American box office crossed the $2 billion mark for the first time since the onset of the pandemic.
New film releases that led the charge included Venom: Let There Be Carnage; Eternals; Ghostbusters: Afterlife; No Time To Die; and of course, the record-setting Spider-Man: No Way Home that now represents the industry's third highest-grossing film in history.
It's worth noting that all five of these films had an exclusive theatrical window.
Cinemark contributed to these box office results in a big way.
On the release of Venom, we set a record for the largest October opening weekend ever for a single film, pre, and post pandemic.
3 for the industry, Spider-Man has now become our No.
1 highest-grossing film of all time, driven by our sustained outperformance on this title.
The fourth quarter's box office success underscores enduring consumer appetite and demand to experience great films in an immersive, shared cinematic environment.
Over 48 million guests visited our global Cinemark theaters in the fourth quarter, and that consumer enthusiasm translated into strong results.
On a worldwide basis, our fourth quarter attendance grew 57% compared to 3Q '21.
Once again, Cinemark surpassed North American industry box office recovery this past quarter, over-indexing by more than 700 basis points when comparing 4Q '21 box office results against 4Q '19.
Our Latin American admissions also outperformed their corresponding industry results by a similar degree.
These significant global attendance and box office results flowed through to our bottom line.
Adjusted EBITDA in the fourth quarter was positive $140 million, and that sizable 4Q result drove positive adjusted EBITDA of $80 million for the full year.
Moreover, exclusive of one-time benefits, we generated positive cash flow during the fourth quarter in both the U.S. and Latin America, another meaningful milestone in our company's recovery from COVID-19.
I'd like to commend our incredible global team for their outstanding planning, execution, and dedication to deliver these tremendous results.
Our Cinemark team has faced monumental challenges during the pandemic.
And what they have accomplished and what they continue to accomplish through their endless perseverance, resourcefulness, strategic thinking and optimism is nothing short of astounding.
While strong film content was certainly a key component of our fourth quarter success, exceptional operating performance and the ongoing execution of our strategic initiatives were also significant factors.
As we look ahead, our overarching focus remains unchanged, and that is to maximize attendance in box office while actively pursuing ancillary revenue opportunities.
Over the course of 2021, the world made tremendous progress combating the ongoing effects of the pandemic.
Although for the time being, the impact of its lingering presence, particularly on our industry and business, still remains.
As a result, as we move forward in 2022, our priorities will continue to focus on: first, effectively navigating the ongoing pandemic; second, fully reigniting theatrical exhibition; and third, positioning our company for ongoing success in the evolving media landscape.
With regard to our first priority of effectively navigating the pandemic, I'm exceptionally proud of the accomplishments our Cinemark team has achieved over the past two years.
These accomplishments include swift and appropriate actions that were taken to preserve cash, minimize expenses and improve our liquidity profile, as well as refine our operating practices, such as streamlining processes, driving new efficiencies, and strengthening operating hours management.
We defined, implemented, and have consistently executed a wide range of new health and safety protocols to protect our guests, communities, and employees.
Additionally, we effectively reopened our entire global circuit and remained open while dealing with frequent fluctuations in content supply and government restrictions.
Our team also continues to skillfully manage through the challenging labor and supply chain dynamics, just to name a few.
We have provided examples of the meaningful impact these actions have had throughout the pandemic during prior calls, and their benefits clearly continued in the fourth quarter, as demonstrated by our sustained market share advances compared to 2019, guest satisfaction scores averaging 90%, and as I mentioned a moment ago, positive adjusted EBITDA and cash flow.
That said, our work navigating the pandemic is not done yet.
At the end of 2021 and throughout most of the first quarter to date, our industry, alongside many others, was affected by another surging COVID headwind brought upon by the Omicron variant.
Fortunately, however, we are encouraged by the recent decline in new cases around the world, as well as commentary by a growing number of health experts, who believe the virus may be transitioning from a pandemic to an endemic.
with regard to moviegoing, as well as consumer sentiment, which has improved to 75% of moviegoers, indicating they are comfortable returning to theaters today and over 80% within the next month.
Theatrical exhibition's ongoing recovery remains highly contingent on the state of the virus, government restrictions, and consumer sentiment, and all of these factors are now moving in a favorable direction.
At the same time we have been navigating through the challenges of the pandemic, we have also been actively working to reignite theatrical moviegoing, our second key priority.
First and foremost, this effort has included actively collaborating with our studio partners to bring new compelling first-run film content back into our theaters on a steadier release cadence.
While health concerns and availability of content have clearly been two of the largest challenges during the pandemic, so too has been the inconsistent film calendar with large gaps between commercial releases.
While Omicron caused another blip in the return to a more normalized release pattern, we are highly optimistic about the film slate for the rest of the year.
New releases this past weekend, uncharted and dog, both exceeded projections, and we expect industry box office will continue to ramp and accelerate with the release of the Batman next week, followed by a long list of additional highly anticipated titles throughout the year, including Doctor Strange in the Multiverse of Madness; Top Gun: Maverick; Jurassic World Dominion; Lightyear; Minions: The Rise of Gru; Thor: Love and Thunder; Black Adam; Aquaman and the Lost Kingdom; Black Panther: Wakanda Forever; and the long-waited -- awaited next installment of Avatar.
And these are just a handful of examples of the franchise films that are lined up for 2022, not to mention the broad range of additional family, drama, comedy, and other genre films that are interspersed throughout the year, providing varied offerings for all audiences.
Furthermore, I'm pleased to report that the majority of films being released theatrically this year will include an exclusive window, with most larger and commercial titles maintaining a 45-day window.
Demonstrated yet again in the fourth quarter of 2021 and this past weekend, a theatrical window continues to produce bigger events, larger cultural moments, and increased box office results with reduced piracy.
It also continues to provide a platform that establishes stronger emotional connections with content, unlike any other distribution channel.
And those connections lead to more sizable brands, franchises, and promotional value for all other windows.
Great films are an essential part of reigniting theatrical moviegoing, and so too is compelling marketing that increases consumer awareness, sentiment, and ticket sales.
To that end, we will continue to lean heavily into a myriad of digital, social, on-screen, and loyalty strategies throughout 2022 to target a wider range of consumers, increase moviegoing frequency and grow our Cinemark audiences.
Over the past few years, we have significantly enhanced the scale of our digital marketing capabilities and reach.
We are now directly connected to more than 20 million addressable guests across our global circuit.
And by way of these connections and the comprehensive omnichannel network we have built, we are consistently delivering billions of impressions each month via social media engagement, personalized emails, and earned media stories showcasing the benefits of the Cinemark moviegoing experience.
These marketing actions have not only been helping to revive moviegoing, but have also increased loyalty, which we've witnessed in the ongoing strength of our market share results and Movie Club program.
After proactively pausing Movie Club memberships at the onset of the pandemic, we fully reactivated the program in the second half of 2021, and we are thrilled to report that we have already returned to new monthly membership gains.
During the fourth quarter, we added 40,000 new Movie Club members, bringing our membership base to within 1% of its pre-pandemic level at approximately 940,000 members.
We continue to receive tremendous feedback about our unique transaction-based subscription program that allows members to roll over unused monthly credits, share credits with friends and family, and receive a meaningful 20% discount on concessions.
Member feedback has also been resoundingly positive with regard to Movie Club Platinum, a new earned premium tier that we launched in September.
By the end of the year, more than 100,000 members achieved this heightened status, which they will enjoy throughout the entirety of 2022.
And that brings us to our third key priority, which is positioning our company for ongoing success in the evolving media landscape.
Examples include our Luxury Lounger recliner seats in over 65% of our U.S. footprint, nearly 300 premium large-format XD and IMAX auditoriums worldwide, immersive D-BOX motion seating across 250 of our theaters, the best sight and sound technology in the industry, and enhanced food and beverage offerings throughout 75% of our global circuit.
Furthermore, we continue to simplify and enhance our transactional processes for tickets and concessions, including our recently deployed Snacks in a Tap online ordering platform that allows guests to purchase food and beverage ahead of time and simply pick up their order upon arrival to our theaters or have it delivered directly to their seats.
These amenities, innovations, and capabilities provide us considerable tailwind as we sort through evolving opportunities and implications driven by the pandemic and near-term shifts in the distribution landscape.
As we concentrate on positioning Cinemark for ongoing success within this dynamic environment, we are focused on five primary strategies.
First is providing our guests an extraordinary experience.
Doing so is fundamental to our business, and Cinemark has a solid reputation and long history of delivering this objective.
That said, we are investing time, energy, and resources to take the experience we provide our guests to the next level.
Our goal is to be top of mind when consumers think about world-class guest service, quality, value, ease, and a premium entertainment destination.
Second is building audiences with an increased focus on attracting a wider range of consumers by expanding the variety of content we offer, as well as utilizing our industry-leading marketing capabilities to drive consumer demand and conversion, as described a moment ago.
Third is growing sources of revenue by creating incremental sales opportunities, such as continuing to expand food and beverage offerings, honing recently implemented e-commerce and theater design initiatives, optimizing pricing, testing new experiential entertainment concepts, and enhancing Cinemark partnerships and brand tie-ins.
Fourth is streamlining processes, which essentially means executing the aforementioned strategies as efficiently as possible, and includes initiatives, such as workforce management, continuous improvement, and utilizing advanced tools, practices, and platforms to free up time spent on administrative tasks and increase focus on our guests, teams, and productivity.
And fifth is optimizing our footprint.
This strategy involves actively assessing our circuit, as well as domestic and international markets, to determine where it is most advantageous to grow, recalibrate and strengthen our circuit to deliver sustained long-term returns.
We believe these areas of focus are best suited to steer us through expected ongoing fluctuations within the media landscape in the near term and position us for continued success over the long haul.
In summary, while our recovery from the pandemic is still ongoing, we are highly encouraged by recent improvements in the state of the virus and associated consumer sentiment.
Fourth quarter attendance demonstrated that consumer enthusiasm for the shared, immersive theatrical moviegoing experience remains strong, and films maintain the ability to become larger than life and generate significant box office results even in the current environment.
As we look ahead, we remain optimistic about the future of theatrical moviegoing and Cinemark.
We are working diligently to position ourselves for ongoing success in the evolving media landscape and to deliver long-term value for our shareholders, guests, communities, and employees.
With that, I will now pass the call to Melissa, who will provide further information about our fourth quarter financial results.
I'm honored to be part of the Cinemark team, and I'm greatly looking forward to meeting the investment community in the near future.
As Sean discussed, we made significant progress in terms of the overall recovery of our industry and our company throughout 2021, and especially in the fourth quarter, which is reflected in our financial results.
Our worldwide attendance was 48.1 million patrons for the fourth quarter.
We delivered $666.7 million of total revenue, $139.4 million of adjusted EBITDA, and $208 million of operating cash flow.
Notably, these worldwide results were driven by robust performance in both our domestic and international segments, with each segment generating positive adjusted EBITDA in the quarter and reporting adjusted EBITDA margins in excess of 20%.
Taking a closer look at our U.S. operations in the fourth quarter, our attendance rebounded to 31.2 million patrons, representing a 45% increase over the third quarter and underscoring the recovery of theatrical moviegoing.
We were able to service these guests with operating hours that were essentially flat to last quarter and approximately 20% below that of pre-COVID, which speaks volumes to the operational efficiencies and technological advances we've achieved since the onset of the pandemic.
Our domestic admissions revenue rebounded to $287.3 million in the fourth quarter on an average ticket price of $9.21.
Our average ticket price continues to be elevated due to three key factors: reduced operating hours resulting in fewer matinee and weekday showtimes; strategic pricing actions; and a higher concentration of premium large-format box office.
box office was generated by our premium large formats.
This is 400 basis points higher compared with the fourth quarter of 2019.
The growth in the average ticket price was partially offset by revenue deferrals related to our loyalty program ramping back up.
concessions revenue was $207.8 million in the fourth quarter and reached 90% of fourth quarter 2019 levels, with an all-time high per cap of $6.66.
Our food and beverage per cap remained above $6 throughout 2021 due to a few factors, including heightened indulgence in food and beverage consumption, particularly within our core concession categories; a mix of moviegoers that tends to skew higher in-purchase incidents; and our operating hours, which, while reduced, remain concentrated in time frames that are more conducive to concession purchases.
Domestic other revenue also benefited from the uptick in attendance and increased more than 50% quarter over quarter to $56.6 million, driven by volume-related increases in screen ads and transaction fees.
Altogether, fourth quarter total domestic revenue was $551.7 million, with positive adjusted EBITDA of $115.9 million and an adjusted EBITDA margin of 21%.
Our international segment also experienced a substantial recovery in the fourth quarter, exceeding our expectations.
All of our theaters were operating throughout the fourth quarter, albeit with certain government-imposed restrictions on operating hours and capacity.
We were able to grow our attendance 84% quarter over quarter to 16.9 million patrons, given a lineup of films that resonated extremely well with the Latin demographics, including Encanto, which is a story based in Colombia; Venom: Let There Be Carnage; Eternals; and of course, the global phenomenon, Spider-Man: No Way Home.
We delivered $115 million of total international revenue in the fourth quarter, including $57.6 million of admissions revenue, $40.4 million in concessions revenue, and $17 million of other revenue.
International adjusted EBITDA was $23.5 million for the fourth quarter, with an adjusted EBITDA margin of 20.4%.
This was our first quarter of positive international adjusted EBITDA since the onset of the pandemic.
Turning to global expenses.
Film rental and advertising expense was 57.5% of admissions revenue, driven primarily by a higher concentration of larger, more successful new film releases with an exclusive theatrical window.
We also increased our investment in marketing to help reignite moviegoing, strengthen loyalty and drive market share, which also flow through this line item.
Concession costs were 17.6% of concession revenue and were up 40 basis points from last quarter.
Supply chain constraints were amplified in the fourth quarter as attendance rebounded.
We experienced product shortages and price increases on certain concession inventory, and we took appropriate actions during the quarter to mitigate much of these impacts.
Fourth quarter global salaries and wages were $83.7 million and increased 24% quarter over quarter as we hired incremental employees to service the expected surge in attendance.
Like most industries, we faced a series of labor challenges, including wage rate inflation and staffing shortages, which we were able to partially offset by streamlining our workforce management processes.
Facility lease expense was $79.2 million and increased 15.1% quarter over quarter.
While largely fixed, lease expense will fluctuate with percentage rent, and common area maintenance increases as volume rebounds.
Worldwide utilities and other expense was $90.8 million and increased 11% quarter over quarter, driven by variable costs, such as credit card fees that grew in line with volumes and higher utility expenses due to expanded operating hours, particularly for our international segment.
Finally, G&A for the quarter was $49.3 million and increased 27.7% quarter over quarter due to investments in cloud-based software and higher consulting costs, legal fees, and stock-based compensation.
Capital expenditures during the quarter were $38.3 million, including $13.9 million for new build projects that had been committed to prior to the pandemic, and $24.4 million for investments to maintain or enhance our existing theaters, such as laser projectors.
And rounding out our fourth quarter results, we generated net income attributable to Cinemark Holdings, Inc. of $5.7 million, resulting in earnings per share of $0.05, another metric that was positive for the first time since the pandemic and represents another milestone in our recovery during the quarter.
As we look forward, we expect 2022 to be a recovery year.
We remain optimistic regarding the full year, particularly with a strong film slate.
That said, our first quarter results will be impacted by the lighter film release calendar due to the Omicron variant, which may lead to negative cash flow during the first quarter.
However, we expect to generate positive cash flow for the full year 2022.
On the cost side, like most other companies in the service industry, we are experiencing inflationary increases due to supply chain constraints and the challenging labor market.
We will continue to mitigate these impacts, wherever possible, in 2022.
Some steps we are taking include implementing incremental labor productivity initiatives, negotiating with an expanded set of vendors, considering alternative concession products, and evaluating strategic price increases.
Turning to our expectations around capital expenditures, while still well below our pre-pandemic ranges, we are beginning to ramp up our investments in our theaters in 2022 and expect to spend approximately $125 million on capital expenditures.
We expect to continue to reap the benefits of our consistent investments in proactively maintaining and enhancing our theaters over the years, which has enabled us to scale back capital expenditures in the near term without hindering our asset quality or guest satisfaction.
In closing, while our recovery from the pandemic is ongoing, we remain highly optimistic regarding the future of theatrical moviegoing and the long-term prospects for our industry, particularly for Cinemark.
We are innovating and evolving in this new operating environment, pursuing what is in the best long-term interest of our key stakeholders to further secure Cinemark's position as an industry leader.
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q4 earnings per share $0.05.
q4 revenue rose 579 percent to $666.7 million.
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We expect to file our Form 10-Q and post it on our website on or before August 6.
You'll find a reconciliation of the non-GAAP measures to the corresponding GAAP measures in the appendix.
Turning to slide 4, we reported operating earnings per share of $0.66, which represents 20% growth over the prior period, or 60% growth excluding significant items in both periods.
Sales activity remains strong and we have exceeded pre-pandemic levels in a number of areas.
Total Life and Health NAP was up 35% over the second quarter of 2020 and up 10% relative to 2019 levels.
Our results also benefited from ongoing deferral of medical care which boost our health margins, solid alternative investment performance, and continued share repurchase activity.
Premium collections remain strong in our underlying margins excluding COVID impacts performed well as expected.
Our capital and liquidity remain conservatively positioned.
We ended the quarter with an RBC ratio of 409% and $336 million in cash at the holding company while also returning $105 million to shareholders through a combination of share repurchases and dividends.
We continue to execute well against our strategic priorities, specifically, successfully implementing our strategic transformation that we initiated in January 2020, growing the business profitably, launching new products, and services, expanding to the right to slightly younger wealthier consumers within the middle-income market, and deploying excess capital to its highest and best use.
Turning to slide 5 and our growth scorecard: As was the case for 6 consecutive quarters prior to the pandemic, all 5 of our scorecard metrics were up year-over-year.
Life sales remained strong, fueled by continued momentum in both our direct to consumer and exclusive field agent channels.
Overall health sales were up almost 90% over the prior period which reflected the first full quarter of the pandemic when state home restrictions were first Instituted.
Total collected life and health premiums were up 1%.
This reflects continued solid growth in Life NAP and persistency of our customer base offset as expected by lower Medicare Supplement premiums.
Annuity collected premiums were up 42% year-over-year, relative to the second quarter of 2019 annuity collected premiums were up 1%.
Client assets in brokerage and advisory grew 33% year-over-year to $2.6 billion fueled by new accounts, which were up 13%, net client asset inflows and market value appreciation.
Sequentially client assets grew 8%.
Fee revenue was up 50% year-over-year to $31 million, reflecting growth in 3rd party sales, growth within our broker dealer, and registered investment advisor, and the inclusion of DirectPath results.
Turning to our Consumer division on Slide 6: We continue to leverage our cross-channel sales program.
Our hybrid sales and service model which blend virtual engagement with our local field, exclusive field agents has led to significant improvements in lead conversion rates, customer acquisition costs, and sales product.
Life and health, sales were up 32% over the prior period, and 19% over the same period in 2019.
Life sales climbed 8% for the quarter to over $50 million reflecting the 6th consecutive quarter of year-over-year growth.
Direct to consumer life sales were level with the record production in the prior period.
Life sales generated by our exclusive field agents were up 23% and comprised over 40% of our total life sales.
Leads from our direct to consumer business supported this growth.
Within our health product lines supplemental health and long-term care sales saw healthy growth over both the second quarter of 2020 and the second quarter of 2019.
These results benefited from initiatives that enable our products to be sold through multiple channels.
Our 3rd-party Medicare Advantage party sales were up 20% in the second quarter.
Medicare supplement sales remain challenged.
Med sales were up modestly over the first quarter.
However, as discussed in previous quarters, our market is experiencing a secular shift away from Medicare supplement and toward Medicare Advantage.
We continue to invest in both our Medicare supplement and Medicare Advantage offerings to ensure we are well positioned to meet our customers' needs and preferences.
Consistent with the first quarter, roughly 50% of our Consumer Division life and health sales were completed virtually.
Consumer selecting to engage virtually held steady, even as communities reopened and vaccination rates increase.
This is a profound change in how we connect with consumers and further validate the transformation we initiated in January of 2020.
It will continue to have significant implications for our business going forward.
Among other things, this change, expand our agents' ability to interact with customers across a broader geographic area.
As I mentioned annuity collected premiums were up 42% as compared to the prior year and up 1% versus 2019.
The number of new annuity accounts grew 16% and the average annuity policy size rose 14%.
Our portfolio of index annuity products continues to be well received by our middle market consumers.
Our recently launched guaranteed lifetime income annuity plus was a key contributor to our second quarter annuity sales growth.
Of course, we continue to maintain strict pricing discipline on our annuities to balance sales growth and profitability.
Participation rates and other terms are reviewed regularly to reflect current macro environment conditions.
Client assets and brokerage and advisory grew 33% year-over-year and 8% sequential to $2.6 billion in the second quarter.
Combined with our annuity account values, we now manage $12.7 billion of assets for our clients.
This has fundamentally shifted the relationship we have with our customer base.
Unlike some insurance products, which can be transactional in nature, investment products tend to create deeper and longer-lasting customer relationships.
We continue to reap the benefits of the shift in the agent recruiting strategy that we initiated several years ago.
We now rely more heavily on targeted recruiting approaches, including personal referrals.
This has periodically resulted in fewer new agent recruits.
However, the new agents we appoint are more likely to succeed and stay with us over time.
Relative to the year-ago period, our producing agent count increased 7%.
Sequentially, our producing agent count was down slightly but overall, our agent force remained stable.
Our securities licensed registered agent force was up 6%.
Improvements in agent productivity had became more important driver of our sales growth then agent count in recent quarters and we have significant runway for future growth.
Turning to slide 7 in our worksite Division: It looks like sales were up sharply in the second quarter as compared to the year-ago period.
We expect to approach 2019 sales levels when access to workplaces improves.
Ongoing pilots and programs to target new employer groups, offer new services, and capture new business continue to progress retention of our existing customers also remained strong with continued stable levels of employee persistency our producing agent count was up 15% year-over-year and 7% sequentially.
Recall that we slowed our agent recruiting during the pandemic due to workplace restrictions.
As a result agent count remains down nearly 40% from pre-COVID levels.
To help boost recruitment and support a return on to pre-COVID production levels, we are rolling out a field agent referral program.
This program is designed similarly to our successful Consumer Division program.
Relative to 2019 levels, our veteran agent count is up 7%.
Retention in productivity levels among our veteran agents who have been with us for more than 3 years remains very strong.
These agents have been the driving force behind our recent sales momentum and are expected to be instrumental in helping to rebuild our overall agent force.
Few revenue generated from our business is more than doubled in the quarter due to the DirectPath acquisition feedback has been strong surrounding the unique combination of products and services we can now bring to the worksite market.
We are realizing early cross sale successes between Web Benefits Design and DirectPath and the pipeline continues to grow.
Along with strong client retention, these business has also generated double-digit increases over both 2020 and 2019 in various metrics.
Turning to slide 8: Our robust free cash flow enabled us to return $105 million to shareholders in the second quarter, including $87 million in share buybacks.
We also raised our dividend 8% in May and 9 consecutive annual increase.
Our capital allocation strategy remains unchanged.
We intend to deploy 100% of our excess capital to its highest and best use over time.
While share repurchases form a critical component of our strategy, organic, and inorganic investments also play an important role.
Turning to the financial highlights on Slide 9: Operating earnings per share were up 20% year-over-year and up 60% excluding significant items.
The results for the quarter reflect solid underlying insurance margins, ongoing net favorable COVID related impacts, strong alternative investment performance, and continued disciplined capital management.
Over the last 4 quarters, we have deployed $337 million of excess capital on share repurchases reducing weighted average shares outstanding by 7%.
Return on equity improved 90 basis points in the 12 months ending June 30, 2021 compared to the prior year period.
The sum of expenses allocated to products and not allocated to products.
Excluding significant items increased by about $6 million sequentially driven by incentive compensation accrual adjustments related to earnings outperformance in the first half of the year.
The increase in expenses over the prior year period also reflects lower a management expenses in 2020 due to COVID related restrictions and the June 30, 2020 conclusion of a transition services agreement related to the long-term care reinsurance transaction completed in 2018.
In general, our expenses continue to reflect both expense discipline and operational efficiency on the one hand and continued targeted growth investments on the other hand.
Turning to slide 10: Insurance product margin in the second quarter was up $17 million or 8% excluding significant items.
Net COVID impacts were $21 million favorable in the quarter as compared to $6 million unfavorable in the prior year period.
Excluding COVID impacts, margins in the quarter remained solid and stable across the product portfolio.
The net favorable COVID impacts in the quarter reflect continued favorable claims experience in our healthcare products, particularly impacting Medicare supplement and long-term care due primarily to continued deferral of care.
This was partially offset by the unfavorable impact of COVID related mortality in our life products.
The favorable COVID impact in the quarter exceeded our expectations as the outlook that we provided on our April earnings call assume that healthcare claims would begin to normalize in the second quarter, including an initial spike in claims due to pent-up demand that did not materialize in the quarter.
Regarding our annuity margin, recall that in the second quarter of 2020, we saw a favorable mortality in our other annuities block unrelated to COVID, which translated to $10 million of positive impacts.
As we noted at the time, this resulted from a handful of terminations and large structured settlement policy, which we expect from time to time in this block, but not on a regular basis.
Turning to slide 11: Investment income allocated to products was essentially flat in the period as growth in the net liabilities and related assets was mostly offset by a decline in yield.
Investment income, not allocated to products, which is where the variable components of investment income flow through increased $40 million, reflecting a solid gain in the current period and our alternative investment portfolio and a loss on that portfolio in the prior year period.
Recall that we report our alternative investments on a 1/4 lag.
Our new money rate of 3.38% for the quarter was lower sequentially reflecting a continuation of our up in quality bias from the first quarter and continued spread tightening in general, partially offset by higher average underlying Treasury rate in the second quarter versus the first quarter.
Our new investments comprised $1.1 billion of assets, with an average rating of single A and an average duration of 16 years.
This higher level of new investment reflected reinvestment of maturing assets and a higher level of prepayment activity in the period.
Our new investments are summarized in more detail.
Turning to slide 12: At quarter end, our invested assets totaled $28 billion, up 8% year-over-year approximately 96% of our fixed maturity portfolio is investment grade rated with an average rating of single A. This allocation to single A rated holdings is up 200 basis points sequentially.
The BBB allocation comprised 39.4% of our fixed income maturities, down 140 basis points.
Both year-over-year and sequentially.
We are actively managing our BBB portfolio to optimize our risk-adjusted returns to the extent suitable and attractive opportunities develop, we may over time balance recent up an quality bias with a modest increase in allocation to alternatives asset-backed securities closed or investment grade emerging market security.
Turning to slide 13: We continue to generate strong free cash flow to the holding company in the sector with excess cash flow, $114 million or 128% of operating income for the quarter and $432 million or 119% of operating income on a trailing 12 month basis.
Turning to slide 14: At quarter end, our consolidated RBC ratio is 409%, which represents approximately $45 million of excess capital relative to the high end of our target range of 375% to 400%.
Our Holdco liquidity at quarter end was $336 million, which represents $186 million of excess capital relative to our target, minimum Holdco liquidity of $150 million.
Even after returning $105 million of capital to shareholders in the quarter, our excess capital grew by approximately $22 million from March 31 to June 30 of this year.
This primarily reflects the strength of our operating results in the quarter and the recent up in quality bias in our investment portfolio.
Turning to slide 15: While uncertainty related to COVID continues, we believe it is very unlikely that any future COVID scenario would cause our capital and liquidity to fall below our target levels.
For that reason, we are no longer running a formal adverse case scenario as we had been doing through the first quarter of this year.
Instead, we are updating a single base case scenario or forecast with upside and downside risks to that forecast.
In our most recent forecast, we expect a continuation of the sales momentum we've seen in the past 5 quarters, we expect a modest net favorable COVID related mortality and morbidity impact on our insurance product margin for the balance of 2021 and the modest net unfavorable impact in 2022.
This assumes that COVID deaths do not worsen in the second half of this year and that healthcare claims begin to normalize after a brief spike beginning in the 3rd quarter due to pent-up demand from deferral of care.
When and if a spike actually occurs and when our health product claims actually normalize is highly uncertain.
So far, we have seen some intra-quarter volatility in our health claims during the pandemic, but nothing that has persisted long enough to establish a trend.
On the mortality side impacting our life products, the number of COVID deaths we will see for the next several quarters is also uncertain, given the recent rise in infections largely from the Delta variant and the potential for material impacts from additional variants.
Certainly, one of the biggest risks to our forecast is how exactly COVID will evolve from here.
But again, we believe, however it evolves, it represents an earnings event for us, favorable or unfavorable, not the capital or liquidity of that.
Assuming no shift in interest rates, we expect net investment income allocated to product to remain relatively flat in this base forecast as growth in assets is offset by lower yields reflective of both the lower interest rate environment and are up in quality shift in asset allocation.
In general, we expect alternative investments to revert to a mean annualized return of between 7% and 8% at some point and over the long term, but the actual results will certainly be more variable with likely more upside potential than downside in the near term given the current economic outlook.
We expect fee income to be modestly favorable to the prior year as we grow our 3rd party Med Advantage distribution and improve the unit economics of that business.
Growth in web Benefits Design, earnings, and the inclusion of DirectPath will also contribute to fee income.
We expect the sum of our quarterly allocated and not allocated expenses tax significant items for balance of the year to be generally consistent with levels reported in the first quarter of this year, allowing for some quarterly volatility.
And finally as COVID related uncertainty diminishes which is certainly will at some point, we expect to manage our capital and liquidity closer to target levels, reducing our excess capital over time.
We are pleased with the healthy results we've generated this quarter and in the first half of the year.
The strength of our diversified business model and the steady execution of our strategic priorities and organizational transformation underpin that success.
The consumer division has met or exceeded pre-pandemic performance and our worksite Division is making meaningful progress.
As we enter the second half of the year, we remain squarely focused on maintaining our growth momentum, building upon our competitive advantages, and managing the business to optimize profitability, cash flows, and long-term value for our shareholders.
Please continue to take care of your health, including vaccinations for those that are eligible.
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q2 operating earnings per share $0.66.
qtrly total revenues $1,073.1 million versus $1,014.2 million.
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You can obtain the release by visiting the media section of our website at cnoinc.com.
We expect to file our Form 10-Q and post it on our website on or before November five.
You'll find a reconciliation of the non-GAAP measures to the corresponding GAAP measures in the appendix.
We delivered another strong quarter with operating earnings per share up 7% over the prior year period, excluding significant items and COVID impacts in both periods.
Our results reflect ongoing deferral of medical care, which continue to boost our health margins, solid variable investment income results and robust share repurchase activity.
Our sales metrics exceeded pre-pandemic levels in a number of areas.
Total life and Health NAP was up 1% over the third quarter of 2020 and up 1% relative to 2019 levels.
As the pandemic continued to pressure an already tight labor market, we experienced a slowdown in new agent recruiting.
Premium collections remained strong, exceeding pre-pandemic levels.
As expected, our underlying margins excluding COVID impacts, performed well.
Our capital and investment portfolio remain conservatively positioned with ample liquidity.
We ended the quarter with an RBC ratio of 388% and $366 million in cash at the holding company.
This is after returning $131 million to shareholders through a combination of share repurchases and dividends.
We continue to execute well against our strategic priorities, specifically, successfully executing on our strategic transformation, growing the business profitably, launching new products and services, expanding to the rise to slightly younger, wealthier consumers within the middle-income market and deploying excess capital to its highest and best use.
Turning to slide five and our growth scorecard.
Four of our five growth scorecard metrics were up compared to 2020.
Relative to 2019, all five metrics were up for the second consecutive quarter.
As a reminder, pre-pandemic, we have delivered five consecutive quarters of growth in all five of our scorecard metrics.
Life sales were up modestly compared to 2020 fueled largely by continued momentum in our direct-to-consumer channel.
Relative to 2019, life sales were up 22%.
Overall, health sales were essentially flat year-over-year but down 16% relative to 2019.
Total collected life and health premiums were down 2%.
This reflects continued solid growth in Life NAP and persistency of our customer base offset as expected by lower Medicare Supplement premiums.
Annuity collected premiums were up 17% year-over-year and up 2% relative to the third quarter of 2019.
Client assets in our brokerage and advisory grew 30% year-over-year to $2.7 billion, fueled by new accounts, which were up 16%, net client asset inflows and market value appreciation.
Sequentially, client assets grew 2%.
Fee revenue was up 41% year-over-year to $28 million, reflecting growth within our broker-dealer and registered investment advisor, higher fees generated by Web Benefits Design, our worksite technology platform and the inclusion of DirectPath results, which is our worksite enrollment and advisory services business.
Turning to our consumer division on slide six.
I continue to be pleased with how we're executing on our transformation to leverage synergies between our agent and direct-to-consumer businesses.
Consumer segment life and health sales were down 2% over the prior period but up 8% over 2019.
Life sales were essentially flat in the quarter.
Direct-to-consumer life sales were up 13% on top of 23% growth in the prior period.
Life sales generated by our exclusive field agents were down 15%.
Health sales were down 5%, largely reflecting continued weakness in Medicare Supplement sales.
As discussed in previous quarters, our market is experiencing a secular shift away from Medicare Supplement and toward Medicare Advantage.
We continue to invest in both our Medicare Supplement and Medicare Advantage offerings to ensure we are well positioned to meet our customer's needs and preferences.
In 2022, we will be launching a new Medicare Supplement product that we believe is more aligned with consumer preferences.
We've also made several enhancements to our Medicare Advantage platform, myhealthpolicy.com and our product offerings to position us well for this Medicare annual enrollment period.
Specifically, we expanded our carrier partners and product offerings.
We now have nearly 3,000 exclusive field agents certified to sell Medicare products, which is up 14% from last year, and we boosted our D2C capabilities through enhanced lead acquisition and sales capabilities.
As I mentioned, annuity collected premiums were up a healthy 17% as compared to the prior year and up 2% versus 2019.
The number of new accounts grew 6% and the average annuity policy rose 10%.
We continue to maintain strict pricing discipline on our annuities to balance sales growth and profitability.
Participation in crediting rates are reviewed regularly to reflect current macro environment conditions.
Client assets in brokerage and advisory grew 30% year-over-year to $2.7 billion in the third quarter.
Combined with our annuity account values, we now manage $13 billion of assets for our clients.
This has fundamentally shifted the relationship we have with our customer base.
Unlike some insurance products, which can be transactional in nature, investment products typically create deeper and longer-lasting customer relationships.
Over the last several years, we have shifted our agent recruiting strategy to focus more heavily on targeted recruiting approaches and boosting the productivity levels of our existing agent base.
This has periodically resulted in fewer new agent recruits.
However, the new agents we appoint are more likely to succeed and stay with us over time.
Until recently, we haven't felt much impact from the tight labor market.
In the third quarter, however, our total producing agent count was down, largely due to fewer first year agents.
Our veteran agent retention and productivity remains strong.
The number of agents that have been with us for at least three years has remained consistent through the third quarter and is up 1% year-to-date.
Productivity among these veteran agents is up 5% over the prior period and up 13% year-to-date.
These more seasoned agents typically generate higher premiums for policy and drive cross-sales of other products, including annuities and health products.
We remain committed to prioritizing agent retention and productivity.
However, we also want to attract new agents.
Therefore, we are experimenting with various pilots and programs to jump-start our new agent recruiting, but expect these near-term headwinds to continue.
Turning to slide seven and our Worksite division.
Worksite sales were up sharply in the third quarter as compared to 2020.
However, sales remained well below 2019 levels.
The emergence of the delta variants caused a number of on-site enrollments to be postponed or canceled.
We expect the pace of worksite recovery to improve as workplaces reopen and COVID disruption subsides.
The workplace, as we know, continues to evolve.
As more companies shift to permanent hybrid work arrangements, we continue to explore new approaches to improve access to existing employer groups and their employees.
At the same time, pilots and programs to target new employer groups and offer new products and services remain a key strategic priority for us.
Retention of our existing customers remain strong and employee persistency within these employer groups continues to be stable.
Our producing agent count was down 5% year-over-year and down 11% sequentially due to the tight labor market.
Asian count remains down more than 45% from pre-COVID levels.
Our recently launched field agent referral program, which is modeled after our consumer division program is generating promising results in its early stages.
Retention and productivity levels among our veteran agents who have been with us for more than three years remains very strong.
These agents have been the driving force behind recent sales activity.
The integration of our fee-based businesses continues to run smoothly.
Fee revenue nearly doubled in the quarter due to both organic growth within WBD, our website technology platform and DirectPath, our worksite enrollment and advocacy services business.
Our average client size in these businesses increased 15%, and our average per employee per month rates were up double digits.
Market feedback on our unique combination of worksite products and services remains positive, and we are realizing meaningful cross-sale success.
Turning to slide eight.
Our robust free cash flow enabled us to return $131 million to shareholders in the third quarter, including $115 million in share buybacks.
This is the highest level of capital return in the past six years.
Our capital allocation strategy remains unchanged.
We intend to deploy 100% of our excess capital to its highest and best use over time.
While share repurchases form a critical component of our strategy, organic and inorganic investments, also play an important role.
Turning to the financial highlights on slide nine.
We generated operating earnings per share of $0.72 in the quarter, which is down $0.07 year-over-year as reported, down $0.05, excluding significant items and up $0.04 or 7% excluding significant items and adjusting for the net favorable COVID impacts on insurance product margin.
We had $3 million pre-tax or $0.02 per share of unfavorable significant items in the current period and none ended prior year period.
And we had $23 million or $0.14 per share of net favorable COVID impacts in the current period as compared to $42 million or $0.23 per share in the prior year period.
The results for the quarter reflect solid underlying insurance margins, ongoing net favorable COVID-related impacts, strong alternative investment performance and prepayment income and continued disciplined capital management.
Over the last four quarters, we have deployed more than $400 million of excess capital on share repurchases, reducing weighted average shares outstanding by 9%.
The operating return on equity was 11.5% for the 12 months ending September 30, 2021.
The sum of expenses allocated to products and not allocated to products, excluding significant items, was flat to the first quarter of 2021 as expected.
In general, our expenses continue to reflect both expense discipline and operational efficiency on the one hand and continued targeted growth investments on the other.
Turning to slide 10.
Insurance product margin, excluding significant items, was down $21 million or 9% in the third quarter as compared to the prior year period, driven by the $19 million year-over-year change in COVID impacts.
The year-over-year decrease in net COVID impacts primarily reflects a decrease in the favorable benefit in our Med Supp product.
Sequentially, the net favorable COVID benefit was essentially flat with the offsetting changes in the impact on our health and life products.
Page 10 of our financial supplement summarizes those impacts by quarter.
The sequential decline in our annuity margin reflects volatility related to the indexed annuity FAS 133 accounting for our embedded derivative reserve, which had a favorable impact in the second quarter and an unfavorable impact in the third quarter.
Excluding COVID impact, insurance margin was essentially flat year-over-year, both in total and by major product grouping.
This is in line with expectations, reflecting the underlying stability of the book of business.
Turning to slide 11.
Investment income allocated to products was up slightly as growth in the net liabilities and related assets was mostly offset by a decline in yield.
Investment income not allocated to products, which is where the variable components of investment income flow through increased $7.2 million or 16%, reflecting solid performance within our alternative investment portfolio and higher prepayment income.
Our new money rate of 3.55% for the quarter was up 17 basis points sequentially, reflecting increased allocation to direct investments and an increase in market yields.
Our new investments comprised $849 million of assets with an average rating of A minus and an average duration of 13 years.
Turning to slide 12.
At quarter end, our invested assets totaled $28 billion, up 5% year-over-year.
Approximately 95% of our fixed maturity portfolio is investment-grade rated with an average rating of single A. This allocation to A-rated holdings is up 20 basis points sequentially.
The BBB allocation comprised 39% of our fixed income maturities, down 180 basis points year-over-year and 40 basis points sequentially.
During the quarter, we established a $3 billion funding agreement backed note program and in early October, we issued an inaugural $500 million funding agreement backing five-year notes.
The program provides a new vehicle for us to leverage our core investment competencies to generate incremental earnings at an attractive return on the underlying capital.
It is complementary to our existing Federal Home Loan bank program because they both improved the company's financial flexibility and draw on similar investment capabilities with slightly different duration and asset allocation strategies.
The combination of the two provides CNO with greater funding diversification and earnings potential.
We expect the FABN program will provide roughly 100 basis points of annualized pre-tax spread income, net of expenses on the notional amount of the notes outstanding.
We'll report the net spread income in NII, not allocated products, just as we currently report the net spread income associated with our Federal Home Loan Bank program on page 17 of our quarterly financial supplement.
Turning to slide 13.
We continue to generate strong free cash flow to the holding company in the third quarter with excess cash flow of $166 million to 179% of operating income, which reflects the solid operating results in the quarter, the continued up in quality bias in our investment portfolio and our decision to increase dividends out of the operating companies to bring the RBC ratio down into our targeted range.
Turning to slide 14.
At quarter end, our consolidated RBC ratio was 388%, which represents approximately $70 million of excess capital relative to the low end of our targeted range.
Our Holdco liquidity at quarter end was $366 million, which represents $216 million of excess capital relative to our $150 million minimum Holdco liquidity target.
Turning to slide 15.
We are not projecting beyond year-end, given the ongoing uncertainty of how the pandemic will evolve from here, particularly as we enter the winter months.
That said, we will share our expectations for the fourth quarter based on our most recent internal forecast.
First, we expect modest growth in Total Life and Health NAP and total collected premiums.
This reflects our continued positive momentum, particularly in our direct-to-consumer business, coupled with the challenges of a very tight labor market and for our worksite business, ongoing delays in office reopenings and in businesses, allowing on-site enrollments.
We expect continued net favorable COVID impacts on our insurance product margin, but at a lower level than recent quarters.
We expect net investment income allocated to products to remain relatively flat as growth in assets is offset by lower yields, reflective of both the lower interest rate environment and our up in quality shift in asset allocation.
We expect net investment income not allocated to products to trend down as compared to recent quarters in light of market conditions in the third quarter; recall that our alternative investments are reported on a one quarter lag.
We expect fee income to be up sequentially and year-over-year as we grow our third-party Medicare Advantage distribution and improve the unit economics of that business.
Growth in web Benefits Design earnings and the inclusion of Direct Path will also contribute to growth in fee income.
We expect the sum of our allocated and non-allocated expenses ex significant items to be generally in line with recent quarters.
Finally, we expect dividends out of the operating companies to be lower than in recent quarters as we absorbed the impact of the revised C1 factors on our consolidated RBC ratio.
As mentioned previously, that will reduce our RBC by approximately 16 points, all else equal, which translates to about $80 million of capital.
For the time being, we are not reducing our target RBC ratio, but we will manage the low end of the 3.75% to 400% target range.
And we will move closer to our $150 million minimum Holdco liquidity target.
I'm pleased with our results for the third quarter, which reflects solid execution against our strategic objectives.
Although uncertainty surrounding the pandemic remains, I am confident that we are well positioned to successfully navigate whatever lies ahead.
The earnings and cash flow generating power of the company remains strong, and our team is laser-focused on building upon our progress in delivering long-term growth and value creation for our shareholders.
Finally, please continue to take care of yourself, including getting vaccinated if you are able.
Stay healthy and stay safe.
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q3 operating earnings per share $0.72.
qtrly book value per share was $42.11, up 15% from 3q20.
qtrly total revenues $968.3 million versus $1,013.5 million.
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You can obtain the release by visiting the Media section of our website at cnoinc.com.
We expect to file our Form 10-K and post it on our website on or before February 26.
You'll find a reconciliation of the non-GAAP measures to the corresponding GAAP measures in the appendix.
And unless otherwise specified, any comparisons made will be referring to changes between fourth quarter 2019 and fourth quarter 2020.
I'm going to start with a discussion of the DirectPath acquisition, we announced last night.
I'll then provide brief commentary on our fourth quarter and full year performance, before turning it over to Paul to discuss our financial results and outlook in more detail.
Turning to Slide 4.
We are very excited about this transaction and the enhanced worksite capabilities it brings to CNO.
The transformation that we announced last year created a Worksite division dedicated to this market.
Growing our Worksite business is the next step in our strategy.
We are significantly expanding our Worksite business to position CNO as a full service provider of Worksite solutions.
DirectPath is a leading national provider of employee benefits management services to employers and employees.
It brings three primary new revenue sources to CNO; employee education services, employee advocacy and transparency services and employer benefits communications and compliance services.
DirectPath operates directly nationwide through approximately 7,000 benefit broker partners.
It serves 400 employers of all sizes from small businesses to Fortune 100 companies, which reflects a covered employee base of more than 2.5 million individuals.
Prior to COVID, Worksite was one of the fastest growing higher multiple businesses for us and in the industry.
We expect that dynamic to resume over the next year or so.
DirectPath builds out our capabilities and gets us deeper into the employer value chain.
It will also create extensive cross-selling and referral opportunities for us.
Through its fee-based structure, DirectPath will diversify our Worksite revenue base.
It adds to our existing high return fee-based businesses that will help drive expansion in our overall ROE.
The purchase price of $50 million was funded out of holding company cash.
There is an additional earn-out, if certain financial targets are achieved.
The transaction is expected to add $0.01 per share to our earnings beginning in 2022.
This transaction aligns well with the M&A playbook we've been executing against, and is reflective of the types of opportunities we may consider again in the future.
Turning to Slide 5 and our full year performance.
We reported operating earnings-per-share growth of 37% for the full year, $387 million of free cash flow or 107% of our operating income and we returned $330 million to shareholders in the form of buybacks and dividends, which reflects 12% of our market cap at the beginning of 2020.
End results underscore the continued strength and resiliency of our diverse product portfolio and distribution channels.
Despite the COVID backdrop, we achieved many important operational accomplishments during 2020.
Within the Consumer division, we've continued to build upon success with our direct-to-consumer life business and cross-channel collaboration efforts.
Integrating these channels has led to significant improvements in overall lead conversion rates and per customer acquisition cost.
Leads generated from our D2C business have become an increasingly important source of new business for our exclusive field agent force.
In 2020, these leads drove two-thirds of the increase in life sales generated by our exclusive field agents.
This year we recognized the opportunity to create a similar multi-channel sales and service experience for the Medicare market.
We launched our new digital health insurance marketplace myHealthPolicy.com.
Our objective is to take the strength of our face-to-face distribution, couple it with our growing online strength and use our unique offerings to become a significant player in the online health insurance market.
This is a competitive space.
The depth and strength of our agent force is the key differentiator.
Just as we successfully scaled and became a top five provider of direct-to-consumer life insurance, we intend to profitably grow the direct-to-consumer healthcare business.
Within the Worksite division, despite COVID, we saw modest growth in our employer client base.
Of course, we faced significant restrictions accessing workplaces to complete employee enrollments.
In response, we focused extensively on building out our virtual and online enrollment capabilities.
For the full year, virtual sales comprised 23% of total production.
Continued premium persistency was another key driver of our Worksite business this year.
Persistency was actually up modestly over historical levels, reflecting the critical value of our -- our consumers' attribute to our protection products and the mix of stable industries we serve.
While we intentionally slowed our agent recruiting efforts in 2020 to align with the softer demand for on-site enrollment due to COVID, we retained our core managers who are critical to rebuilding our sales force and driving our ultimate recovery.
As I've shared in previous quarters, in 2020, we made significant investments in supporting the safety, wellness and financial well being of our associates, customers and agents in response to the pandemic.
We expanded our commitment to diversity, equity and inclusion and named a senior director to support our ongoing initiatives to develop and embed ENI practices across our organization.
We also made progress in our ESG efforts, the principles of which are central to our overall business strategy.
CNO is now a signatory to the United Nations principles for responsible investment, which commits us to incorporating ESG principles in our investment analysis and reporting framework.
We expect to formally adopt the SASB and TCFD reporting frameworks this year when we publish our updated corporate social responsibility report.
Turning to Slide 6 and our results for the quarter.
Our fourth quarter results benefited from the ongoing deferral of medical care which drove continued strong health margins.
Our performance was also boosted by a particularly robust alternative investment earnings.
Operating earnings per share were up 17%.
Our book value per diluted share excluding AOCI was up 8%.
During the quarter, we saw continued improvement in several key metrics.
However, the wave of COVID late in the fourth quarter created a headwind to certain sales and agent metrics.
Premium collections remained strong across both divisions, but reflect the impact from weaker health sales in recent periods.
Expenses were higher in the quarter and higher than we signaled on previous calls, driven primarily by the acceleration of spending on growth initiatives.
This was a conscious decision.
The strength of our business and cash flow in 2020 enabled us to capitalize on opportunities to support the continued growth of our franchise beyond the pandemic.
We saw this as an opportunity to build capabilities for future growth and differentiation.
Paul will provide more details.
Fee income was down, reflecting solid growth in fee revenue, offset by spending related to the development and marketing of myHealthPolicy.com.
Our capital and liquidity positions remained solid.
We issued $150 million in subordinated debt in November and ended the quarter with an RBC ratio of 411% with $388 million in cash at the holding company.
Turning to our growth scorecard on Slide 7.
Three of our five metrics were up year-over-year.
Life sales were up 6% for the quarter and 12% for the full year, fueled by both continued strong direct-to-consumer growth and a sharp increase in sales from our exclusive field agents.
Collected life premiums were up 3%, reflecting solid growth in NAP in recent quarters and the continued strong persistency of our customer base.
Collective health premiums were down 4.7%, largely resulting from the impact of softer in-person health sales in recent quarters.
Annuity collected premiums were up 6% for the quarter, reversing the trend in recent quarters.
Client assets under management grew 18% to nearly $1.8 billion.
Of this growth, approximately half was driven by new client assets.
Fee revenue was up a healthy 19% to $36 million, reflecting growth in third-party sales and growth within our broker-dealer and registered investment advisor.
Health sales remained challenged, down 22% over the prior year, driven by a 29% decline in Medicare supplement sales.
As we've discussed previously, we're in the midst of a secular shift away from Medicare supplement toward Medicare Advantage.
Helping customers navigate the complex Medicare landscape has been a core strength of our exclusive field agents.
Our approach to the shift in consumer preferences is to leverage the strength of both our field agents and our new digital health marketplace to capture incremental Medicare Advantage sales.
At the same time, we will continue to maintain a strong presence in the Medicare supplement market, which consistently delivers a compelling loss ratio and provides a meaningful contribution to our health margin.
It's also a key differentiator.
Very few peer companies manufacture and sell Medicare plans.
As a reminder, Medicare supplement sales are reflected in the new annualized premium, while Medicare Advantage sales are reflected in the fee revenue.
Turning to our Consumer division on Slide 8.
Sales of life insurance remained strong, up 17% for the quarter and up 19% for the full year.
Direct-to-consumer life sales, which comprised about half of our total life sales, were up 10%.
Life sales generated by our exclusive field agents were up 26% supported by leads shared from our direct-to-consumer channel.
This cross-channel dynamic has resulted in improved productivity metrics, such as lead conversion rates and customer acquisition costs.
Again, this underscores the value of our unified distribution model as growth in one channel is able to feed growth in the other.
As I mentioned earlier, we are working to create the same dynamic on the health side of our consumer business.
During this year's Medicare annual enrollment period, consumers were able to purchase Medicare products from us online or from one of 2,800 tele-sales and local exclusive field agents certified to sell Medicare plans.
With the launch of myHealthPolicy.com marketplace, we created pathways for our tele-agents to refer consumers to local agents and for field agents to refer consumers to a tele-agent or the platform itself.
As a result, our Medicare Advantage policies sold in the fourth quarter increased 3% over the prior year and total third-party policies were up 5%.
myHealthPolicy.com accounted for 14% of our third-party health sales in the quarter.
Our producing agent count was down 3%, which makes our sales momentum and productivity even more impressive.
Due to the resurgence of the pandemic, COVID-related quarantines kept a number of our exclusive field agents and clients from engaging in face-to-face appointments.
COVID restrictions also remain more stringent in the areas of the country where our agents are more concentrated.
As a reminder, to be counted as producing, our agents need to sell at least one policy each month.
Our total exclusive agent count, which includes our field and tele-sales agents was actually up 3% for the full year.
We continue to grow the number of securities licensed financial representatives, which is core to how we are evolving our field force and changing the relationship with our clients.
Turning to Slide 9 and our Worksite division.
Collected premiums remained strong as the profile of our existing employer groups has translated to continued healthy levels of employee persistency.
We saw continued sequential improvement in our Worksite sales in the fourth quarter with sales up 61% over the third quarter.
Relative to the year ago period, however, sales were down 41%.
Given recent increases in COVID infection rates across the country and workplaces opening up more slowly, we continue to expect a steeper recovery path in the Worksite business.
We launched a new group product in the fourth quarter called monthly income protection group term life.
This is a unique group life product that is designed to replace monthly income rather than paying a lump sum death benefit.
Web Benefits Design delivered solid results in 4Q, including a 3% increase in the average per employee per month charge.
WBD cross-selling activities drove 5% of overall NAP in the quarter.
The division will be co-managed by current Worksite President, Mike Hurd and by DirectPath, Chairman and CEO, Mike Byers.
Both will report to me and Mike Byers will join our executive leadership team.
Turning to Slide 10.
We returned $117 million to shareholders in the fourth quarter, including $100 million in share buybacks.
For the full year, we deployed $263 million on buybacks at an average price of $18.17.
Our capital allocation strategy remains consistent.
We intend to deploy 100% of our excess capital to its highest and best use over time.
While share repurchases form a critical component of our strategy, organic and inorganic investments also play an important role.
It's worth noting that most of our organic investments in the fourth quarter flowed through our income statement as operating expenses rather than as capital expenditures.
These investments remain mission-critical to our future success.
Paul will provide more color in his remarks.
Turning to Slide 11.
Over the past two years, we've also been making minority investments in various InsurTech and FinTech companies.
Through CNO ventures, we seek to generate attractive returns, develop relationships, source and track opportunities, and ultimately invest in various companies that are disrupting the insurance and financial space.
We fully expect these investments to stand on their own merits and deliver attractive returns.
They also serve as important vehicles for us to collaborate and innovate.
We seek out companies that are strategically relevant, particularly those we can partner with, to help us improve our digital engagement with consumers, accelerate our speed to market with new products and services and/or enhance our technology.
To date, we have invested a total of $21 million in five companies, including HealthCare.com, Human API and Kindur.
We expect to complete a few similar transactions per year.
The portfolio will remain small relative to our total invested assets, but impactful in other ways.
Turning to the financial highlights on Slide 12.
Operating earnings per share were up 17% in the fourth quarter and up 21% excluding significant items, benefiting from favorable health insurance product margins, driven by continued customer deferral of care related to COVID and by strong net investment income, resulting from significant outperformance of our alternative investments.
Earnings per share also benefited from our share repurchases, which reduced our fourth quarter weighted average share count by 7%.
We deployed $100 million of excess capital on share repurchases in the fourth quarter and $263 million for the full year.
Partially offsetting the increase in insurance product margin and investment income in the quarter was an increase in expenses and a decrease in fee income, both driven by our decision to fast track spending on growth initiatives in the second half of 2020 in the context of accelerating trends relating to all things virtual and digital and supported by strong earnings in the period.
These initiatives included spending related to myHealthPolicy.com, which flows through as an expense in our fee income line as it relates to activities supporting our fee revenue.
Other examples of growth initiatives in the period include spending on virtual sales and service capabilities, market access, data analytics and various initiatives designed to improve our policyholder customer experience.
All of these investments flowed through our income statement on the expenses allocated to products line.
In the 12 months ended December 31, 2020, we generated operating return on equity excluding significant items of 12%, which compares to 10.4% in the prior year period.
The favorable impact was driven by our lower initial portfolio rates, which manifested from asset turnover in the annuity portfolio in the third quarter of 2020.
Those lower rates drove a favorable adjustment to the embedded derivative reserve related to our fixed index annuities.
Separately, as part of the assumption update, we lowered the new money rate assumption to 3.5% in 2021 and 3.75% in 2022, but that did not create material unlocking impacts.
Turning to Slide 13 and our product level results.
Our overall margin in the fourth quarter was up $30 million or 15%.
Excluding significant items, it was up $9 million or 4%.
This included a net favorable COVID impact of $18 million, driven by the deferral of care in our healthcare products and reflects modest spread compression in our annuity product and generally stable results in our life and health products ex-COVID.
Turning to Slide 14 and our investment results.
Investment income allocated to products was essentially flat in the period as the favorable impact of the 4% increase in net insurance liabilities was largely offset by a 19 basis point year-over-year decline in the average yield on those investments to 4.83%.
Sequentially, the average yield declined five basis points consistent with our prior guidance.
Investment income not allocated to products increased $32 million year-over-year to $58 million driven by strong alternative investment performance.
This translates to an annualized return on our alternative investments of 24% as compared to a mean expectation of between $7 million and 8%, reflecting outperformance driven by private equity realizations and strong private equity -- excuse me, private credit results.
Our new money rate of 3.58% was down 50 basis points both year-over-year and sequentially with the sequential change driven primarily by tighter credit spreads.
Turning to Slide 15.
At quarter end, our invested assets were $27 billion, up 9% year-over-year.
Approximately 95% of our fixed maturity portfolio is investment-grade rated with an average rating of single A. The BBB allocation comprised 42% of our investment-grade holdings, up slightly from the prior quarter.
Turning to Slide 16.
We continue to generate strong free cash flow to the holding company in the fourth quarter with excess cash flow of $122 million or 142% of operating income this quarter and $387 million or 107% of operating income on a trailing 12-month basis.
Turning to Slide 17.
At quarter end, our consolidated RBC ratio was 411%, down from 428% at September 30.
This represents approximately $55 million of excess capital relative to the high end of our targeted range of 375% to 400%.
Our Holdco liquidity at quarter end was $388 million, which represents $238 million of excess capital relative to our target minimum Holdco liquidity of $150 million or approximately $185 million of excess net of the capital deployed this quarter on the DirectPath transaction.
We had intentionally maintained a more conservative posture in the context of ongoing COVID-related uncertainty.
Turning to Slide 18 and our outlook for the remainder of the year.
We continue to run base and adverse case scenarios that are generally aligned with certain rating agency assumptions regarding COVID-19 infection rates, death rates and related economic impacts.
From a top-line perspective, in our base case, we expect the continuation of the positive momentum that we experienced in the second half of 2020.
From an earnings perspective, we expect two sets of headwinds in '21 relative to 2020.
The first relates to COVID where we expect to trend toward more normal claims experience in our healthcare products as consumers and healthcare providers continue to become more accustomed to COVID-related protocols and/or as the benefits of vaccines take hold.
In our base case, we expect this will translate to net mortality and morbidity impacts that are modestly favorable in the first half, modestly unfavorable in the second half and neutral for the full year.
It's also worth noting that the decline in sales in 2020 due to COVID will reduce insured product margin in 2021 and beyond, all else equal.
The second set of earnings headwinds in 2021 relate to investment income, particularly a potential for reduced income from alternative investments and from opportunistic trading as compared to significant outperformance in 2020.
Lastly, continued pressure from low interest rates generally, which has lately been coupled with tighter spreads, will continue to pressure earnings.
We expect this will translate to flat net investment income allocated to products within our insurance product margin as growth in the asset base will likely be offset by a decline in the yield on those assets.
These headwinds notwithstanding we expect a modest offset from a slight decline in expenses, mostly in the second half of the year as we continue to drive operational efficiencies, while also continuing to invest in growth initiatives.
Regarding free cash flow and excess capital, we exhausted our life NOLs in 2020, which will put modest pressure on our free cash flow conversion rate in 2021.
Nevertheless, still healthy levels of free cash flow generation in our base case scenario on top of our excess capital position at year end 2020 should result in share repurchase capacity, exceeding our actual share repurchase activity in 2020.
Importantly, even in our adverse case, which is intended to capture scenarios far out in the tail, we expect to be able to manage RBC Holdco liquidity and debt leverage within our targeted levels, pay our dividends to shareholders and still had a modest amount of share repurchase capacity, albeit at much reduced levels compared to our base case.
Turning to Slide 20 -- to Slide 19.
2020 was an incredibly challenging year on many fronts.
Our pandemic response and financial results demonstrated the resilience of our organization and proved that we can emerge from the crisis even stronger while continuing to support our associates, agents, customers and communities.
There's no question that difficult and uncertain conditions remain.
In many respects, we have less visibility into 2021 than we had in 2020.
The lack of short-term clarity should not detract from the long-term view of our prospects.
Our franchise remains strong and our financial position is robust.
Longer term I couldn't be more optimistic about the future of this company and our ability to capitalize on the opportunity before us.
Please continue to stay healthy and safe.
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qtrly book value per share was $40.54, up 28% from 4q19.
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Dave Lesar, our CEO; Jason Wells, our CFO; and Tom Webb, our Senior Adviser, will discuss the company's first quarter 2021 results.
Actual results could differ materially based upon various factors as noted in our Form 10-Q, other SEC filings and our earnings materials.
We will also discuss earnings guidance and our utility earnings growth target.
In providing this guidance, we use a non-GAAP measure of adjusted diluted earnings per share.
We previously referred to our earnings guidance as guidance basis EPS, and we'll now refer to it as non-GAAP earnings per share or utility EPS.
Similarly, we will refer to our 6% to 8% non-GAAP utility earnings per share target growth rate as utility earnings per share growth rate.
As a reminder, we may use our website to announce material information.
Information on how to access the replay can be found on our website.
Now I'd like to turn the discussion over to Dave.
We are observing a sense of normalcy starting to return here in Texas and in many of our other jurisdictions.
Just as important to me is that I look forward to an opportunity to meet you in person and tell you about the amazing things we have accomplished in less than a year and what our strategy entails moving forward.
I want to share with everyone our excitement about the progress CenterPoint is making and our continued belief in the utility assets that we operate.
We believe they are premium assets and want you to believe that too.
Today, we will provide an update on the continued disciplined execution of our strategy that we outlined during our Investor Day just five short months ago.
I hope you see that we are developing a track record of being consistent and accountable against the goals that we set.
As you know, I'd like to lead with headlines, and we have some worthy ones to cover this quarter.
First, we delivered very strong results for the first quarter of 2021, including $0.47 of utility EPS.
Because the higher natural gas prices are pass-through costs for our business, they did not impact this quarter's utility results.
In addition, our first quarter results are in line with recent historical trends in which the first quarter contributed close to 40% of the full year utility EPS.
We are, of course, reaffirming our full year utility earnings per share range for 2021 of $1.24 to $1.26 and our long-term 6% to 8% utility earnings per share annual growth target.
We are off to a great start for the year, so let's check the utility earnings box as being on track.
The second big headline is, of course, the announced agreement to sell our Arkansas and Oklahoma gas LDCs, which is anticipated to close by the end of the year, subject to regulatory approvals.
These are premium assets, and this was demonstrated by the level of interest we saw and, of course, in the price we got for them.
The landmark valuation was 2.5 times 2020 rate base.
This outcome was well beyond what even the most optimistic observers thought we would achieve.
We saw extraordinary interest from over 40 parties, 17 of which made bids, including strategics, infrastructure funds and PE firms.
There are a number of key takeaways from this great outcome.
First, it validates our strong and stated belief that our remaining gas LDCs are significantly undervalued, and investors should rethink their position as to the value of our remaining gas LDCs in our share price.
This also illustrates the strength, viability and value of the broader gas LDC industry.
The premium multiple these assets garnered in the marketplace shows that investors continue to see natural gas as an essential fuel that is efficient, valuable and affordable energy source.
This transaction demonstrates how we can efficiently finance our industry-leading rate base growth.
This is a perfect example of the efficient capital recycling strategy we committed to you on our Investor Day.
It's a simple model.
You sell at 2.5 times rate base and invest at 1 times rate base.
Naturally, this begs the question if we would consider more LDC sales in the future.
Currently, we're content with our utility portfolio mix.
But that being said, if we see another opportunity to recycle capital in a similarly attractive way, we would explore it as part of our broader strategy.
Our Investor Day plan highlighted that we had the opportunity to spend an additional $1 billion over our current $16 billion five-year capital plan.
At this price, the LDC transaction will provide us with $300 million of incremental proceeds on an after-tax basis compared to the five-year plan we showed you on our Analyst Day.
We will first look to deploy this $300 million in incremental proceeds into high-value utility capital spend opportunities that are part of those additional $1 billion in capital opportunities.
This incremental capital spending is likely to be spent in 2022 and begin to flow into earnings in 2023 and allow us to continue to provide reliable, essential services to our customers.
Therefore, this transaction will not impact our long-term growth plans or earnings trajectory.
On the contrary, we believe this will even more strongly support consistent 6% to 8% utility earnings annual growth rate in our industry-leading 10% rate-based CAGR targets.
We previously committed to you a 2Q sales announcement, and we delivered on that.
So let's also check that box as being done.
Turning now to the Enable transaction.
We anticipate the transaction between Enable and Energy Transfer to close in the second half of the year.
We remain absolutely focused on reducing and eliminating our midstream exposure through a disciplined approach.
And to reiterate what we said when we announced the news of a transaction back in February, completing this transaction also will not change our 6% to 8% utility earnings per share annual growth target or our 10% rate base CAGR.
So that box stays checked as we remain on track to reduce midstream exposure.
Turning to the impacts from the winter storm, Uri.
Last quarter, many of you questioned the incremental gas costs and the likelihood and timing of recovery.
We said that the storms impacts won't change the utility earnings per share target range and they will not.
We also said we believe we had a handle on the issue but needed some time to work through it with our regulators.
Let me give you an update on what progress we have made on that front.
First, in part by actively engaging, auditing and challenging our gas suppliers, we have reduced our incremental gas costs by over $300 million since our initial estimates, resulting in reduced customer incremental gas cost exposure of $2.2 billion.
We won't stop pursuing these actions, because we believe this is the right thing to do for our customers.
We are also beginning to seek the timely recovery of these costs through early adjustments to our normal cost recovery mechanisms.
We have started recovery in Arkansas and Louisiana, including some carrying costs.
Both Arkansas and Oklahoma have also passed legislation for securitization.
In Minnesota, we are pursuing recovery of storm-related costs, including some carrying costs due to the existing gas cost recovery mechanism over a two-year period.
And in Texas, a state-sponsored securitization bill on incremental gas cost has already passed through the house and is being considered by the Senate.
We believe there is good momentum behind this bill.
So while not completely behind us, we are getting closer to checking the incremental gas cost box.
We have said all along that we have strong regulatory relationships, and that belief is supported by our progress in working through this event.
On the electric side, the Texas PUC is undergoing a complete turnover, and we look forward to building our relationships with the new team.
There's also been some legislative progress around the proposal to increase grid resiliency in Texas.
In Texas, several proposed bills have been moving that are intended to protect systems and customers from a repeat of the electric disruption we saw in February.
We are very encouraged by the progress, and we see this as an opportunity for the system as a whole to find better ways to serve our community.
We remain on course for a $16 billion-plus capital spending program and industry-leading 10% compounded annual rate base growth target over the next five years.
For 2021, we are on track to spend the full $3.4 billion outlined on our Investor Day.
Similar to our earnings, there is a seasonality to our capital spend where we typically ramp up spending as the year progresses.
As stated previously, we have opportunities above our current $16 billion five-year plan and the $300 million in incremental proceeds from the ultimate sale of our Arkansas and Oklahoma LDC assets transaction will provide additional capacity for us to pursue some of these, if we so choose.
So let's check the capital spending box as being on track.
We have talked about our industry-leading organic customer growth rates.
Despite the impact of COVID, we again saw about 2% growth rates quarter-over-quarter, reinforcing the value of the fast-growing markets that we serve.
That organic growth plays a part in keeping our service costs reasonable for our customers.
In addition, we take a disciplined approach to reducing our O&M expenses to benefit our customers.
We are on track to reduce O&M by 2% to 3% in 2021.
However, given the incremental opportunity set we see to reinvest in our business, we may take the decision to reinvest some O&M savings back into our utility assets this year.
This is a great luxury to have.
So for 2021 on O&M, let's check that box as being on track.
Next up is our commitment to environmental stewardship.
We are well under way in developing and then announcing what we believe will be an industry-leading carbon strategy.
On that front, a critical constructive piece of news was recently received in Indiana, where we received a very positive Indiana Director's report for our IRP.
Though our Indiana IRP does not require approval, the directors report has provided us with the confidence that we are headed down the right renewable path with both regulators and our communities.
Since our last earnings call, we have reviewed our updated ESG plans with our Board and are preparing a rollout of our transition to net zero.
We should be in a place to disclose these exciting plans in the third quarter.
Since this is still a work in progress, we cannot check the box here, but I am very happy with the progress that we are making.
I've been looking forward to these calls every quarter, because we have so many exciting things to share with you as we execute our long-term strategy that we outlined on Investor Day.
I strongly believe that the strategy we laid out and the progress we have made so far more than demonstrates what a unique value proposition CenterPoint offers.
Just to echo Dave's sentiment, we're looking forward to seeing more of you in person in 2021.
To continue the theme of execution and delivery, I want to start by reviewing our quarterly results with you as well as provide some incremental details on a few events Dave highlighted.
Let me get started with our first quarter earnings.
On a GAAP basis, we reported $0.56 for the first quarter of 2021 compared to a loss of $2.44 for the first quarter of 2020.
Looking at slide four.
We reported $0.59 of non-GAAP earnings per share for the first quarter of 2021 compared to $0.60 for the first quarter of 2020.
Our utility earnings per share was $0.47 for the first quarter of 2021, while midstream investments contributed another $0.12 of EPS.
The notable drivers when comparing the quarters are strong customer growth across all of our jurisdictions and rate recovery, which makes up $0.05 of the favorable impact.
Our disciplined O&M management contributed another $0.03 of positive variance for the quarter.
The growth drivers were partially offset by the $0.09 from share dilution due to the large equity issuance back in May 2020 and $0.03 due to the nonrecurring CARES Act benefit we received last year.
Turning to slide five.
We are very pleased with the high level of interest we received for our Arkansas and Oklahoma gas LDCs as we've conveyed through the entire process.
As Dave said, there were interested parties across the spectrum, which drive a highly competitive auction process.
The successful outcome emphasizes the high-quality nature and supportive regulatory frameworks that are present in all of our businesses.
We're preparing to commence the regulatory approval process and anticipate a close by the end of the year.
The integrated nature of the operations between these two jurisdictions will also accelerate the carve-out in integration process with the new owners as we work toward closing and will facilitate delivering on our commitment of reducing any remaining allocated O&M.
As shown on the slide, this transaction priced at $2.15 billion, inclusive of $425 million of incremental gas cost recovery.
The $1.725 billion in proceeds, after the natural gas cost recovery, represents a multiple of 2.5 times 2020 rate base and a multiple of 38 times 2020 earnings for those businesses.
This earnings multiple is based on the purchase price of $1.725 billion, reduced by approximately $340 million of implied regulatory debt compared to $36 million of 2020 full year earnings.
This transaction multiple, consistent with some of the highest multiples paid for gas LDCs, demonstrates that the market continues to see gas LDCs playing a pivotal role in our country's energy supply by providing affordable, efficient and lower carbon energy sources for our customers.
The net proceeds from this sale are estimated to be $1.3 billion after tax and closing costs as our Arkansas and Oklahoma assets have a relatively low tax basis of approximately $300 million.
While there's been a lot of focus on tax leakage, we were clear at our Investor Day that our five year plan assumed full tax on the gain on sale for these assets given the low tax basis.
Therefore, the headline is the competitive auction process will, at close, result in generating an additional $300 million in after-tax proceeds than what was assumed in the original five year plan.
To zero in on the use of the incremental $300 million of proceeds, we will prioritize funding an increase in our capital investment plan.
It is important to note this incremental capital will be deployed in 2022, and as a result, will likely impact 2023 earnings and beyond once the capital has been approved in rate base.
We will also evaluate using some of the excess proceeds to delay the start of our at-the-market equity program that was originally slated for 2022.
We're grateful I have these options.
I'd also like to reiterate that this disposition will not change our 2021 utility earnings guidance range.
It is also important to reiterate Dave's point that the premium multiple achieved through this transaction as well as the performance of the systems through the recent winter storms reinforces that there are many states that see natural gas as a viable low carbon fuel source and the market has been undervaluing these assets.
And as renewable fuels continue to advance, our systems will have the proven capabilities to adapt and evolve along with them.
Turning to slide six.
Dave discussed that we are still on pace to close the Enable and Energy Transfer merger in the second half of this year, and then we'll look to liquidate our midstream position in a disciplined but efficient manner.
As a reminder, we will have $385 million of energy transfer preferred units that we can liquidate at any time after the merger closes.
The $200 million of Energy Transfer common units we will receive in the merger will be registered through a process that will likely take two to three months after close.
We will have the flexibility to either dribble those units into the marketplace or sell through up to five block offerings.
As we've noted in the past, our negative tax bases at Enable will carry over to Energy Transfer units and will result in an effective 50% tax on the sale.
As previously discussed, we continue to explore tax mitigation strategies across the company to offset the burden that may come with a common unit sales and continue to have confidence we can reduce the tax leakage.
As a result, I'd like to reaffirm that the sale of the Energy Transfer units will not change our utility earnings per share growth target of 6% to 8% annually.
As Dave mentioned, we have actively worked with suppliers, which has, in part, helped to reduce the overall incremental gas costs from the winter storm to $2.2 billion, down from $2.5 billion we signaled last quarter.
In addition, CenterPoint regulators and legislators have all been working over the past few months to align on cost recovery methods that suit the needs of all of our stakeholders.
As laid out on slide seven, we have multiple mechanisms available to us for cost recovery.
two states have already initiated interim recovery.
Another two states have enacted a legislation enabling securitization, and Texas has a securitization bill pending.
Between the securitization, the sale of the gas LDCs and the interim rate recovery, we now expect between $1.6 billion and $1.7 billion of the total incremental gas costs to be recovered before the one year anniversary of the storm, assuming the Texas securitization bill is signed into law.
We are grateful for the diligence of our regulatory team and the constructive support of our commissions across our jurisdictions for getting us to this point.
Turning to our financing updates.
We closed our $1.7 billion CERC senior notes offering on March 2, which included $1 billion of floating rate notes and $700 million of fixed rate notes, both due in 2023.
The proceeds for the $1.7 billion issuance were used to pay for the incremental gas costs for the winter storm and the notes have an optional redemption date at any time on or after September two of this year, giving us full flexibility to pay down this debt consistent with our regulatory recoveries.
Recovery of the carrying costs and the majority of the impacted states such as Texas, Louisiana, Arkansas and Oklahoma will help offset the incremental interest cost from this debt issuance.
Our current liquidity remains strong at approximately $2.1 billion after the issuance of the senior notes proceeds and the payments made for the incremental gas costs.
Our long-term FFO to debt objective is between 14% and 14.5% and is consistent with the expectations of the rating agencies.
We continue to actively engage with them, and they are comfortable with the outlook and thresholds we've indicated.
I'd like to reiterate, we have no large equity issuance needs over our current planning horizon and can now reevaluate the need for our ATM program in 2022, depending on how we utilize the expected proceeds from our LDC asset sale.
I hope it's becoming clear that our story is streamlining nicely as we prove to you, our investors, that we're delivering on our plan as outlined.
We are reducing our exposure to nonutility businesses, realigning our balance sheet to reduce our reliance between intercompany borrowings and parent debt and committing to efficiently fund our industry-leading rate base growth.
These are the updates for the quarter.
Both Dave and I are excited about the direction CenterPoint is taking, and we cannot wait to share more good news with you as we continue to execute on our plan throughout 2021 and beyond.
Over to you, Tom.
Five months after our strategy-revealing Investor Day, CenterPoint, as you just heard, is well under way executing its strategy.
It's dispensing with volatile noncore nonutility businesses, think Enable; implementing efficient financing, think gas LDC sales; introducing clean energy, think coal closures, renewable additions and much more; and improving performance, think continuous improvement, a whole new culture.
Dave and Jason already have highlighted details about each of these as strategic changes are nearing completion, our premium utility operation is humming.
I hope you see it.
I hope you feel it.
We really sweat the details, so you don't have to.
We have superior rate base growth, delivering needed capital investment.
Our growth rate target of 10% outstrips the peer average of about 7%.
Our resulting utility earnings per share growth target at 6% to 8% every year is well above the peer average of 5%.
And our customer growth at 2% is something we would celebrate at my old company, with top quartile customer satisfaction, we still seek to hold down customer price increases, reducing our O&M cost by 1% to 2% every year.
Coupled with customer growth, this creates a lot of headroom for the needed capital investment.
Five months ago, we showed you our five year plan to reduce costs 1% to 2% each year.
We added the detail for 2021 during our last call.
And here, you can see our progress in the first quarter.
We plan for a fast start with 2021, down 2% to 3%, with results in the first quarter faster yet.
Please keep in mind, some of this is timing.
We still expect to reduce costs by about 2% to 3% for the year.
As you know, one of our tools is our continuous improvement initiative.
We improve our processes from the ground up to enhance safety every day; quality, doing things right the first time; delivery, doing things on time; cost, we see and eliminate waste; and morale, higher and higher every day.
Each day, I observe more who are proud to wear the colors.
Continuous improvement takes time to ramp up.
It's a powerful process.
It shifts dependence from heroic individual work to better processes that can be repeated.
As we succeeded eliminating human struggle, the cost will fall out.
My favorite chart is on the right.
We take on the headwinds.
We take advantage of the tailwinds.
We deliver our earnings per share commitment consistently every year.
We really do sweat the details, so you don't have to.
As I have experienced elsewhere, this management team may do so well on cost reductions that it can pull ahead work from next year, reinvesting savings to benefit our customers sooner.
We did this last year.
We maximize resources for customers and deliver our commitment to you, our investors.
No more, no less, a win-win.
Dave, Jason and this superb leadership team know the secret sauce.
They are working for both our customers and our investors, no or's here.
Back to you, Dave.
I want to reemphasize what we consider critical elements as we transform CenterPoint into a premium utility we believe it can be.
We will continue to deliver sustainable, predictable and consistent 6% to 8% earnings growth year after year.
With our industry-leading organic customer growth and our disciplined O&M management, we believe we can generate robust capex and 10% rate base growth while continuing our focus on safety.
We also look forward to unveiling our enhanced ESG strategy that will put us as an industry leader for a net-zero economy.
We will continue to keep our eyes on maintaining and enhancing our balance sheet and credit profile.
We have executed on our capital recycling strategy through our announced gas LDC sale at 2.5 times rate base and investing at 1 times rate base, and we will continue to explore opportunities to do more of this.
We remain absolutely committed to delivering an economically viable path to minimize the impact of our midstream exposure and eventually eliminate it.
And finally, as we work to move toward a fully regulated business model, we continue to stay focused on our utility operations and improving the experience for our customers.
I hope you will join us on this path of transitioning CenterPoint into a premium utility.
While myself, our team and our employees are only 10 months into this new journey, I could not be more pleased by the momentum we have, what we've accomplished and the bright future we see for CenterPoint.
What you see is the new CenterPoint, where you can expect consistent and predictable earnings and rate base growth, world-class operations and growing service territories and a commitment to delivering on our promises to you, our investors.
We sweat the details, so you don't have to.
We will now take questions until 9:00 a.m. Operator?
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centerpoint energy - qtrly earnings per share $0.56.
q1 non-gaap earnings per share $0.59.
q1 earnings per share $0.56.
reaffirming 2021 utility earnings per share guidance range of $1.24 - $1.26 and reiterating 6% - 8% utility earnings per share annual growth rate target.
on path to deliver 10% compound annual rate base growth through $16 billion 5-year capital plan.
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Dave Lesar, our CEO; Jason Wells, our CFO; and Tom Webb, our Senior Adviser, will discuss the company's second quarter 2021 results.
Actual results could differ materially based upon various factors as noted in our Form 10-Q, other SEC filings and our earnings materials.
We will also discuss non-GAAP EPS, referred to as Utility EPS, earnings guidance and our utility earnings growth target.
In providing these financial performance metrics and guidance, we use a non-GAAP measure of adjusted diluted earnings per share.
As a reminder, we may use our website to announce material information.
Information on how to access the replay can be found on our website.
Now I'd like to turn the discussion over to Dave.
Now while we are always keen to discuss our great future, we are planning to discuss our exciting longer-term strategy updates at our Analyst Day, which will take place on September 23 here in Houston.
Though this is our second Analyst Day in less than 12 months, we feel that it is warranted as we are now well into our strategic transition and we want to use that forum to update our investors on our longer-term business plan, earnings capacity, financial metrics and the net zero emissions target that we will be sharing with you.
We are also excited for the opportunity to spend more time with you in our hometown here in Houston and to see you in person.
Let me quickly remind you of just how far we have come in the last year.
A year ago, CenterPoint was going through a strategic review at the direction of our Business Review and Evaluation Committee or BREC.
The goal of the review was to optimize shareholder value and address specific shareholder concerns.
Initially, in my role as Chairman of the BREC, and then later when I became CEO, it was crystal clear to me that while the company had a great asset base and talented employees, we have not unlocked all of our potential, and certainly had not taken full advantage of all of our inherent opportunities.
Before the BREC process, CenterPoint was targeting modest earnings per share growth and had reduced capital spending in our regulated businesses.
We had work to do to strengthen our regulatory relationships.
The company had previously announced a strategic review of Enable, but had not found an executable opportunity to actually reduce exposure to its midstream investments.
Our O&M expenses were historically growing, and we needed a stronger balance sheet.
We had minimal renewables opportunities on our radar screen, and we were in search of a permanent CFO.
So yes, the list of challenges was long.
I mentioned these not to revisit the adversities our investors and company we're experiencing, but to highlight for you the aggressive speed and approach used by our new team to attack and resolve the challenges and headwinds we faced.
Let me quickly recap our progress.
I substantially refreshed and diversified our Executive Committee, and we now have what I believe is a best-in-class management team.
We announced an updated five-year strategy that prioritizes investment in our regulated businesses and boosted our planned capital spending by about 25% to $16 billion.
We instituted a 10% utility rate base CAGR, well above our peer group average of 8%.
That rate base growth then supported an increased long-term utility earnings per share target growth rate of 6% to 8%, which is also above the consensus peer average of 6%.
To efficiently fund our growth, while repairing our balance sheet, we announced the sale of our Arkansas and Oklahoma gas LDCs at a landmark earnings multiple of 2.5 times rate base.
We were instrumental in the Enable and Energy Transfer merger which, once closed, will provide us a pathway to eliminate our exposure to midstream.
And we announced a commitment to a 1% to 2% annual reduction in O&M over the five years to keep our customer rate growth manageable.
We recently announced changes to our Board leadership to bring our governance structure in line with best practices and shareholder expectations, and we will be announcing a commitment to an industry-leading net zero carbon commitment at our Analyst Day.
So in my view, we certainly have walked the talk, and through timely and aggressive actions overcome many of the headwinds we faced.
Now it's time for CenterPoint to switch gears.
We are going to use the same aggressive approach and organizational speed to take advantage of the tailwinds we have today.
Our strong execution, coupled with a privilege to serve some of the fastest-growing regions in our country, have created the foundation for CenterPoint to trade as one of the premium utilities in the U.S. Believe me, we are just getting started.
Our six-month financial performance in 2021 has been strong.
Today, we are raising our 2021 Utility earnings per share guidance range to $1.25 to $1.27.
This 8% growth projection in '21 puts us at the high end of our 6% to 8% Utility earnings per share annual growth target.
And as a reminder, this increase in guidance is after the dilution impact of the 18% increase in our share count that we experienced in 2020.
When we compare our Utility earnings per share growth to analysts' long-term consensus growth for our peers, we are now in the top decile.
And as you would expect, we are also reaffirming both our long-term 6% to 8% Utility earnings per share annual growth target and 10% rate base compound annual growth rate target.
This 10% rate base growth also exceeds the average 8% rate base growth of our peer group.
For the second quarter of 2021, we reported strong results, including $0.28 of Utility earnings per share compared to $0.18 for the second quarter of 2020.
The comparison to Q2 2020 is a bit noisy, and I believe essentially irrelevant as both quarters included a number of one-off items.
Q2 2020 results also reflected the impact of COVID on our business.
The bottom line for me is to focus on the reality that our Utility earnings per share is expected to grow 8% this year over last year, and then target 6% to 8% growth from there.
Our O&M continuous improvement programs have strengthened our results for the first six months of 2021.
We are already on track to save over $40 million in total O&M costs this year alone, while maintaining our focus on safety.
This is almost 3% of our annual O&M cost.
However, when compared to last year's second quarter, our O&M costs are actually up a bit.
Again, this is just more noise that I don't worry about as last year's second quarter O&M costs were artificially depressed by the impact of COVID and disconnect moratoriums.
We are still absolutely committed to our continuous improvement cost management efforts in our target of 1% to 2% annual reductions in O&M.
In fact, as a result of our excellent 2021 results to date, we were in the fortunate place to be able to already make a management decision and begin pulling recurring O&M work forward from 2022 into the last six months of this year and still be able to hit the 8% Utility earnings per share growth for this year.
This allows us the luxury of reducing near-term run rate O&M costs today, and immediately reinvesting them for the future long-term benefit of our customers and investors.
We continue to see industry-leading organic customer growth rates.
Despite COVID, our Houston service territory continues its 30-plus years of consistent growth.
Overall, we saw about 2% customer growth for electric and 1% for natural gas for the first six months of the year when compared to the prior year.
The growth is supported by the highest level of new home starts in Houston since 2005.
This continued and consistent growth reinforces the value of the fast-growing markets that we serve.
This organic growth plays a key role in keeping our service costs reasonable for our customers.
Moving to capital investments.
We have invested approximately $1.5 billion for the first six months of this year and are still on track to invest approximately $3.4 billion for the full year 2021.
More importantly, we now have better line of sight to additional capital investment opportunities beyond the five-year $16 billion investment plan we outlined on our Analyst Day.
New Texas legislation provides more tools to transmission and distribution utilities to improve the resiliency of the electric grid and helps minimize the risk of prolonged outages and allows us to put all of this into rate base.
Some of these laws include the ability to lease and put into rate base, backup battery storage capacity for resiliency and to assist with restoring power.
Next, the ability to lease and put into rate base emergency generation, which may include mobile generation capabilities.
The ability to immediately procure, store and put into rate base long lead time items related to restoring power, and the allowing of economic versus resiliency justifications for new transmission projects.
Based on initial analysis, these legislative changes provide support to increase our five-year capital investment plan by at least $500 million.
Now this is on top of the $1 billion in reserve capital investment opportunities we previously identified during our last Analyst Day, but were not incorporated into that plan.
Just as important, we will have the ability to efficiently fund $1.1 billion of these incremental opportunities.
This is primarily due to the incremental proceeds expected from the sale of our gas LDCs and the execution of tax mitigation strategies, which Jason will discuss shortly as well as additional debt, assuming a roughly 50-50 cap structure.
Even better, all of this is before the additional proceeds we anticipate from the sale of Energy Transfer units given the significant appreciation in value since the Enable and Energy Transfer merger was announced.
We are in the midst of quantifying what the whole new slate of organic opportunities will look like, and we'll be in a position to provide more detail at our Analyst Day in September.
However, just as a teaser, we are confident that we will be in a position to announce an increase to our previous five-year investment plan, fund that increase with no incremental equity and execute on projects that will continue to improve the resiliency and safety of our systems for the benefit of our customers, a very nice trifecta.
Now I will briefly touch on strategic initiatives, which we have announced over the recent months, including our gas LDC sale and our planned exit of our midstream investment.
We know that investors are highly focused on the ultimate completion of these initiatives, and we believe we will achieve our timing expectations.
We continue to make progress on the gas LDC sale and still anticipate closing by the end of the year.
We are working closely each day with Summit to secure regulatory approvals for the sale and to successfully transition that business.
Turning to the Enable transaction.
We still anticipate the transaction between Enable and Energy Transfer to close in the second half of the year.
We remain absolutely focused on reducing and then eliminating our midstream exposure through a disciplined approach.
Now to be clear, it would be very unlikely for either of these transactions to close prior to our September Analyst Day.
And finally, to reiterate what we said when we announced the news of these two transactions in our last quarterly call, completing these transactions will not change our industry-leading 6% to 8% Utility earnings per share growth target or 10% rate base compound annual growth rate target.
Finally, I want to highlight the Natural Gas Innovation Act that recently passed in Minnesota.
This is a landmark law that establishes a new state regulatory policy that creates additional opportunities for a natural gas utility to invest in innovative, clean energy resources and technologies, including renewable natural gas, green hydrogen and carbon capture and further demonstrates the forward-thinking mindset of the jurisdictions that we serve.
This is a successful outcome for all stakeholders as we work to collectively achieve lower greenhouse gas emission reduction goals.
With the approval from the Minnesota Public Utility Commission, a utility can invest up to 1.75% of our gross operating revenue in the state annually.
This opportunity increases up to 4% of gross operating revenues by 2033.
Under the new law, we expect to submit our first innovation plan to the PUC next year.
This law aligns with our steadfast commitment to environmental stewardship and more specifically, our carbon reduction goals.
Our customers are asking for ways in which we can deliver not only safe and reliable, but cleaner electricity and gas, and we are working to achieve that.
Across jurisdictions, we are collaborating to find ways to introduce more renewable fuels into our systems as we firm up our goal to achieve a net zero target.
We look forward to unveiling this in September during our Analyst Day.
For now, I'll just remind everyone how thrilled I am to be able to deliver these messages.
As I've said, this marks one year for me as CEO, and a lot has changed.
I look forward to the calls every quarter, so I can proudly share our team's accomplishments with you.
I strongly believe the strategy we have laid out and the progress we have made so far more than demonstrates what a unique value proposition CenterPoint offers.
While I don't quite have a full year with CenterPoint under my belt, I am just as energized as Dave by our recent execution and more importantly, about the path we are on to becoming a premium utility.
Let me get started by discussing our earnings for the second quarter of 2021.
On a GAAP earnings per share basis, we reported $0.37 for the second quarter of 2021 compared to $0.11 for the second quarter of 2020.
Looking at slide four, we reported $0.36 of non-GAAP earnings per share for the second quarter of 2021 compared to $0.21 for the second quarter of 2020.
Our Utility earnings per share was $0.28 for the second quarter of 2021, while Midstream investments contributed another $0.08.
As Dave mentioned, there were a few onetime items for both quarters that made the comparison a bit noisy.
This included favorable impacts for the second quarter of 2021, inclusive of $0.05 attributable to deferred state tax benefits.
Of this $0.05 in total, $0.03 of the benefit was related to legislation in Louisiana that eliminated the NOL carryforward limitation period.
This amount is included in our Utility earnings per share results.
The remaining $0.02 of benefit was due to Oklahoma's revision of the corporate tax rate, which is a favorable driver in our midstream segment.
Our 2020 Utility earnings per share included a negative $0.06 impact due to COVID.
Beyond those onetime items, other notable drivers for the second quarter of 2021 include customer growth and rate recovery, which contributed about $0.04 of favorable impacts as well as miscellaneous revenue contributing another $0.02 of favorable impacts.
These were partially offset by a negative $0.02 impact from the share dilution resulting from the May 2020 issuance and a negative $0.03 for unfavorable O&M variance.
So there's a lot of noise when comparing to second quarter of 2020 as that was the quarter that most impacted by COVID worldwide.
I look through that noise, and I think you should, too.
The bottom line is we expect to grow our Utility earnings per share 8% this year and target 6% to 8% thereafter.
And that's what we should all focus on.
As Dave mentioned, O&M is a bit noisy this quarter as well.
The key takeaway is we are delivering on our planned efficiencies of over $40 million in cost reductions for the year, and are now beginning to accelerate O&M work from 2022.
This will help improve reliability of our service for our customers while sustaining growth for our shareholders.
With two quarters of financial results behind us, we have good line of sight to our full year 2021 earnings per share outperformance.
Our disciplined execution and tailwinds led us to raise our Utility earnings per share guidance range to $1.25 to $1.27 per share for the full year, which is at the high end of our 6% to 8% annual Utility earnings per share growth target.
Beyond 2021, I want to reiterate, we are focused on growing Utility earnings per share at 6% to 8% each and every year.
And we look forward to discussing incremental drivers over a longer-term horizon during our September Analyst Day.
Moving to a discussion of future capital opportunities as shown on page five.
We are currently developing our full analysis of additional capital opportunities resulting from bill signed into effect in Texas during the last legislative session.
There will be some shorter-dated opportunities that develop such as the ability to procure long lead time items or to lease a portion of battery storage or backup generation across our footprint, and then some longer-dated projects such as transmission opportunities through economic justification.
Based on our first look, we have confidence that new Texas legislation will support at least $500 million of incremental capital investment opportunities over just our current five-year plan.
This number will likely increase as we work with stakeholders to refine the implementation of this new legislation and develop the longer-dated plan to incorporate some of these opportunities.
We are confident the new tools we have been providing will help create a more resilient electric grid and help reduce the risk of prolonged outages.
Regarding the previously identified incremental $1 billion, we may be able to deploy above our 2020 Analyst Day plan of $16 billion.
This incremental capital spending is likely to be allocated toward recurring system improvements to accelerate the improvement in resiliency, reliability and safety of our services.
We will provide a more comprehensive update on this additional capital spend in our upcoming Analyst Day, but it is important to highlight any incremental capital we include in this plan won't begin contributing to earnings until 2023 at the earliest, as we will begin recovering incremental spend the year following the investment.
As far as the funding sources for these incremental capital opportunities, we continue to take advantage of a number of tailwinds that will allow us to incorporate additional capital spend.
As we reported last quarter, and Dave reinforced, we will receive an incremental $300 million of proceeds above our original plan once the gas LDC sale closes.
Additionally, we have continued to refine the estimate of the incremental benefit for the method we use to determine the amount of repairs expense that can be deducted for tax purposes.
While we are still refining this study, we have confidence that the benefit will generate at least $1 billion in incremental tax deductions, resulting in at least $250 million in additional cash to us and likely more.
This enhanced method for determining repairs expense is an efficient way for us to fund these capital investment opportunities, which improve the resiliency and safety of our systems for the benefits of our customers.
The combination of these improved sources of funding, coupled with debt, that will be authorized under our regulatory capital structure, supports incremental investments of at least $1.1 billion.
And importantly, this amount is before we consider any additional proceeds due to the unit appreciation of Energy Transfer.
Moving to the financing updates.
We closed our $1.7 billion debt issuance in May, which was comprised of $700 million of three-year floating rate notes, $500 million of five-year fixed rate notes at 1.45% and $500 million of 10-year fixed rate notes at 2.65%.
The proceeds was to refinance $1.2 billion of near-term maturities at the parent as well as to pay down commercial paper.
Based on our current financing plans, we have no further issuance needs for 2021.
Our current liquidity remains strong at $2.2 billion, including available borrowings under our short-term credit facilities and unrestricted cash.
Our long-term FFO to debt objective is between 14% and 15%, aligning with the Moody's methodology and is consistent with the expectations of the rating agencies.
We continue to actively engage with them and they have informed us that they are comfortable with the outlook and thresholds we've indicated.
Based on our current financing plans, we will not issue any incremental equity through an aftermarket equity program in 2022, as previously discussed, and are evaluating if or when we would initiate it beyond that.
As we've said in the past, we take our commitment to be good stewards of your investment very seriously and realize our obligation to optimize stakeholder value.
I am energized with our execution over the last year, and I am confident we are positioning CenterPoint to be a premium utility moving forward.
Those are the updates for the quarter.
As mentioned, we'll be hosting an Analyst Day here in Houston on September 23.
We look forward to the opportunity to engage and introduce you to the depth of the CenterPoint team then.
This will be Tom's last call with us, as Tom's work here at CenterPoint is winding down.
I want to extend our sincerest appreciation to Tom for his counsel and support over the past year.
I have, and I know we all have benefited greatly from his time here.
I finally remember your visit to Kalamazoo a year ago, went over Dana's cooking in a bottle of nicely aged Bordeaux wine, I explained how I was busy and retired.
I was humbled to be asked and honored to help in a very small way on your extensive checklist.
Top of your list was identifying and attracting one of the very best CFOs in the business.
You already have made immediate critical improvements that will be lasting.
CenterPoint has transformed in less than a year, selling noncore, nonutility businesses, think Enable securing more efficient financing, think LDC sales, driving clean energy, think coal closures, renewable growth and a lot more to come, and accelerating performance, think continuous improvement.
We are witnessing the emergence of a premium utility with sustainable, predictable earnings per share growth every year.
I trust you see it, feel it.
We truly do sweat the details so you don't have to.
You'll see bumps in the road, serious challenges like the winter storm that impacted many utilities.
I bet you had doubts.
But watch CenterPoint, this team promptly addresses challenges to protect our customers and deliver for you, our investors.
With important capital investment to deliver needed improvements for our customers, our rate base growth target at 10% substantially outstrips the peer average at about 8%.
Our resulting annual Utility earnings per share growth target of 6% to 8% is strong.
We expect it to be at the high end of the range this year.
And as Dave mentioned, that's top decile.
Customer growth of 2% is just the level our peers would celebrate.
Coupled with O&M reduction of 1% to 2% a year, this creates a lot of headroom for needed capital investment.
Our five-year plan includes 1% to 2% cost reduction every year.
Our plan for this year is for a fast start, down more than $40 million or 3%.
And with a fast start, we already are pulling work ahead from 2022.
The cost reductions, favorable tax changes, lower financing cost, economic recovery and more allow us to reinvest $20 million for our customers now and possibly more later.
This performance reflects good business decisions and continuous improvement.
It comes from management commitment, experienced teams and ground-up process improvements that enhance safety every day; quality, doing things right the first time; delivery, doing things on time; cost, we see; and eliminate waste and morale higher every day.
This continuous improvement process is powerful.
It's just dependence from heroic individual work to better processes that are repeatable; as we eliminate human struggle, the cost fall out.
And one of my favorite charts is on the right.
As Dave often observes, we take on the headwinds, we take advantage of the tailwinds.
We deliver our earnings per share commitment consistently every year.
We deploy surplus resources to our customers.
It is all about our customers and our investors.
We did this last year.
We're doing it again now.
No ors, just ands here.
It's fun to be part of a premium winning utility.
CenterPoint is a great company with wonderful people and a huge investment opportunity.
As Jason said, you've been a valuable part of our team, and we're grateful for the time you have shared with us.
This has been one exciting year for CenterPoint.
I could not be more pleased by the momentum we have, what we've accomplished and the bright future that we see for ourselves.
We have truly been sweating the details so you don't have to.
And I believe our effort is evident in our consistent and more predictable earnings and rate base growth in our world-class operations in growing service territories.
I hope you now have the trust that we will continue our commitment to deliver on our promises to you, our investors.
I believe the best is yet to come.
I'd also like to remind everyone to register for our upcoming Analyst Day on September 23 here in Houston.
We will now take a few questions.
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centerpoint energy q2 earnings per share $0.37.
q2 earnings per share $0.37.
qtrly adjusted earnings per share $0.36.
raising 2021 utility earnings per share guidance range to $1.25 - $1.27.
on path to deliver 10% compound annual rate base growth over 5 years.
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David Lesar, our CEO; Jason Wells, our CFO, will discuss the company's third quarter 2021 results.
Actual results could differ materially based upon various factors as noted in our Form 10-Q on their SEC filings and our earnings materials.
We will also discuss non-GAAP EPS, referred to as utility EPS, earnings guidance and our utility earnings growth target.
In providing these financial performance metrics and guidance, we use a non-GAAP measure of adjusted diluted earnings per share.
As a reminder, we may use our website to announce material information.
Information on how to access the replay can be found on our website.
Now I'd like to turn the discussion over to Dave.
As you know, we laid out our first ever 10-year plan back at our Analyst Day.
We expressed that and are reiterating today that we are a management team who can execute.
We believe we will continue to demonstrate that for you.
This marks my sixth quarter with CenterPoint and Jason's fifth.
I'd like to first start by laying out how we are building a consistent track record of delivery.
First, if you recall, the CenterPoint value proposition we laid out at our recent Analyst Day focused on our efforts to achieve sustainable earnings growth for our shareholders, sustainable, resilient and affordable rates for our customers and a sustainable positive impact on the environment for our communities.
I believe we are continuing down the path of achieving this value proposition.
Each quarter under the new CenterPoint leadership, we have met or exceeded quarterly utility earnings per share and dividend expectations.
We have increased our annual utility earnings per share guidance for both 2020 and 2021.
And as I will discuss shortly, today, we are increasing our 2021 utility earnings per share guidance once again.
Our 2021 through 2024 annual utility earnings per share growth rates of 8% are top decile among our peers, and we also expect to achieve at the mid- to high end of our 6% to 8% utility earnings per share guidance range each year from 2025 to 2030.
I am confident in our team's ability to achieve that growth.
Last year, we had a $13 billion 5-year capital plan.
We increased that to $16 billion in our 2020 Analyst Day.
In this year, we increased it yet again to $18 billion plus.
We introduced our first ever 10-year capital plan.
CenterPoint remains ripe with opportunities across our footprint to expand and harden our system to benefit customers and shareholders.
Our current 10-year plan contains no external equity issuances.
We will fund the equity portion of our capital needs to internally generated operating cash flows and our already announced strategic transactions.
We are also executing on our plan to become a pure-play regulated utility as we approach the closing of the Enable ET merger expected by the end of this year and then our subsequent sell-down of our midstream stake.
With the recent settlement agreement among the parties in Arkansas, we are also moving toward the completion of our LDC asset sale.
The remaining steps include the Oklahoma approval, which is anticipated to be received in November and the all-party settlement in Arkansas is expected to be approved by mid-December.
And with our newest announcement around our industry-leading ESG targets, we are on the path to executing our goals to be net 0 on direct emissions by 2035.
We continue to believe that this is an achievable path delivering for customers, regulators, investors and the environment.
In the third quarter of 2020, I said that I will not be satisfied until we are recognized as a premium utility.
In the theme of our Analyst Day was again establishing a path toward a premium.
I believe we are making tremendous strides down that path.
The storm headwinds of up to 90 miles an hour, leaving 470,000 of our Houston Electric customers without power.
Within three days, we had 95% of the power restored for those customers.
And within five days, the whole system was back online.
Now for this quarter's headlines.
Our year-to-date financial progress has been strong.
We are reporting a utility earnings per share beat and are raising our full year outlook this quarter.
For the third time this year, we are increasing our 2021 utility earnings per share guidance this time to $1.26 to $1.28 for the full year.
And for the first nine months, we've already achieved nearly 80% of that full year goal.
More importantly, we are still targeting an 8% annual growth rate for 2022 to 2024.
So this raises our guidance for 2022 utility earnings per share to $1.36 to $1.38.
For the third quarter of 2021, we reported $0.25 of utility EPS, which compares to $0.29 in the third quarter of 2020.
In the third quarter of this year, we had a onetime impact to earnings of $0.04 per share related to our most recent Board implemented governance changes.
Jason will get into more detail on the variances shortly.
As I mentioned earlier, we have increased our five-year capital plans to $18 billion plus over the next five years and $40 billion plus over the next 10 years.
This is nearly a 40% increase in our five-year capital investment plan since the third quarter of 2020.
This includes new opportunities that stem from the latest legislative session in Texas.
One of those opportunities was the ability to lease and put into rate base mobile generation units.
We move quickly on this opportunity and procured [Indecipherable] five-megawatt and 30-megawatt mobile generation units, some of which we were able to deploy during Hurricane Nicholas as backup while crews worked to repair our system.
And recently, during an ERCOT forecasted Texas wide load-shedding event, the Texas PUC [Indecipherable] to make sure our units were ready to support customers.
We were the first the utility in the state to act on this legislative opportunity and had them in place to utilize them in the way the law intended.
We look forward to mobilize quickly on the other tools provided to us by the Texas legislature to improve the resiliency of the electric grid and help reduce the risk of prolonged outages.
We already have an outstanding RFP for additional mobile generation, which could bring our total up to 500 megawatts and hope to have this procured in the coming months.
We believe that with the deployment of these additional tools, we will be able to mitigate some of the impacts of future extreme weather events on our customers.
Due to recent weather events in both Louisiana and Texas, we are running slightly behind on our capital spending plans on a year-to-date basis.
These weather events pulled away many of our contract crews, so they could provide mutual assistance to our fellow utilities, especially in Louisiana.
Therefore, while deployed elsewhere, they cannot work on our capital projects, but we have a catch-up plan in place and anticipate making the short fall of.
In anticipation of continued labor shortages and as we ramp up our capital plans in the coming years, we have now moved to procure additional contractor resources from multiple suppliers.
We believe that this will help to support continuity and crews on a long-term basis and reduce the impact of any labor disruptions in executing our $40 billion-plus capital spend over the next 10 years.
We remain committed to our continuous improvement cost management efforts and our target of 1% to 2% average annual reductions.
We've already realized the benefit of some of these improvements this year.
We stated in the second quarter that we could accelerate approximately $20 million of recurring O&M work forward from 2022 into this year if we had the available resources.
So far, we've achieved approximately 20% of this goal year-to-date and remain confident around our team's ability to continue to execute toward this goal for the balance of the year.
This allows us the luxury of reducing near-term run rate O&M costs which helps to mitigate rate pressures while maintaining continued focus on reliability and safety of our service for customers, all while sustaining growth for our shareholders.
In addition to O&M continuous improvement efforts, we are fortunate to operate in growing jurisdictions.
This combination plays a key role in keeping our growth plans affordable for our customers.
As we discussed during our Analyst Day, Houston is the fourth largest city in the U.S. and the only one of those four that's growing.
Houston's organic growth has been multi-decades long.
That organic growth rate continued for yet another quarter.
We are also seeing strong growth in many of our other jurisdictions as well.
On a year-over-year basis, we saw about 2% customer growth for electric and 1% for natural gas through September.
Again, this organic growth is the luxury, most other utilities just do not have.
Now let me shift gears and give a brief regulatory update.
A recent highlight in Indiana happened just this past week.
As part of our long-term electric generation transition plan, we received the CPCN approval from the Indiana Utility Regulatory Commission for the first tranche of solar generation, 75% of which we expect to own and 25% due a PPA.
This approval shows the commission's alignment and support of our 2020 IRP, which bridges our coal generation into a mix of lower carbon and renewable sources.
We anticipate the CPCN decisions for our Gas CT plant in the second or third quarter of 2022 and the incremental solar PPA in the third quarter of 2022.
As outlined in our IRP, we are targeting to own approximately 50% of our total solar generation portfolio.
Our continued build-out of renewables is a key driver in achieving our net zero direct emissions goal by 2035.
Shifting to gas cost recovery from the February winter storm.
We continue to make progress.
And as we previously mentioned, we have mechanisms in place or have begun recovery in all jurisdictions.
We are happy to report that just this past week, we reached a settlement on the prudence proceedings supporting securitization of 100% of gas costs in Texas, including all of related carrying costs.
We look forward to the commission approval of the agreement.
We anticipate a financing order for the securitization bonds by the end of the year.
With this time line, we anticipate receiving the proceeds sometime mid next year.
In Minnesota, we started a recovery as of December and are working with stakeholders on ways to reduce the impact on our customers.
We filed a rate case earlier this week, and also proposed an alternative rate stabilization plan to address the unique set of circumstances customers are experiencing.
The full rate case requests $67.1 million per year, while the rate stabilization plan requests $39.7 million per year and an extended recovery period for winter storm costs.
The proposed rate stabilization plan would resolve the rate case and limit the bill impact on customers, in part by recovering the winter storm costs over a 63-month period.
We're asking the PUC to review and approve the stabilization plan by the end of this year, which would allow rates to take effect on January 1.
To summarize, we are working with stakeholders to align our focus on safety and related investments while minimizing the burden to our customers.
Largely as a result of mechanisms in our Houston Electric in Indiana South gas jurisdictions, we have recently received approval for $40 million of increased incremental annual revenue.
As discussed in our Analyst Day, we anticipate approximately 80% of our 10-year capital plans to be recovered through interim mechanisms, which demonstrates the constructive jurisdictions in which we operate.
In Texas, our PUC is now appointed a fourth commissioner.
Jason and I have now had the opportunity to meet all four commissioners and are very encouraged by the dialogue and expertise that all of these commissioners bring to the PUC.
We look forward to continued engagement with the commissions in all of our jurisdictions.
So those are the headlines for the quarter.
I remain excited about what's to come for CenterPoint.
We have a growing track of execution and believe it more than demonstrates what we can do in the near future and the unique value proposition that CenterPoint offers to you.
This marks my one year of earnings calls with CenterPoint and the story keeps getting better.
To reemphasize Dave's message, we are focused on establishing a track record of consistent execution, and I fully believe the best is yet to come here at CenterPoint.
On a GAAP earnings per share basis, we reported $0.32 for the third quarter of 2021 compared to $0.13 for the third quarter of 2020.
Looking at slide five, we reported $0.33 of non-GAAP earnings per share for the third quarter of 2021 compared to $0.34 for the third quarter of 2020.
Our utility earnings per share was $0.25 for the third quarter of 2021, while midstream investments contributed another $0.08.
Favorable growth in rate recovery, lower interest expense and reversal of the net impacts from COVID last year, each contributed $0.01 of favorability.
Board implemented governance changes recorded this quarter and another $0.03 of unfavorable variance attributable to weather and usage.
For context, we experienced 73 fewer cooling degree day in Houston for the third quarter of 2021 compared to the third quarter of 2020.
We estimate that each cooling degree day above normal has approximately a $70,000 a day impact in our Houston Electric business.
Turning to slide six.
For the first nine months, we've achieved nearly 80% of our full year 2021 utility earnings per share guidance, which we are now raising to $1.26 to $1.28.
And as Dave said, we are also raising our utility earnings per share guidance for 2022 to $1.36 to $1.38, which is an 8% increase from our new 2021 estimates.
Looking beyond that, we are focused on delivering 8% annual utility earnings per share growth through 2024 and at the mid- to high end of our 6% to 8% annual utility earnings per share range over the remainder of our 10-year plan, strong growth each year and every year, no CAGRs for earnings.
The last thing I'll mention for this quarter is the share count.
Our preferred Series B shares converted into 36 million common shares as of September 1, further reducing the number of share classes outstanding.
We expect the conversion will have no impact on earnings as the increase in shares is effectively offset by the termination of our Series B dividends.
Going forward, I want to reiterate we have no external equity included in our current [Indecipherable] and only expect our share count to modestly increase from dividend reinvestment or incentive plans.
Now I want to offer some color on the capital plans supporting our rate base and utility earnings per share growth.
We've spent approximately $2.3 billion year-to-date on capital investments.
As Dave mentioned, we had some slight delays due to recent weather events and are focused on making that up over the coming months.
We outlined on our Analyst Day the three buckets that we are investing in, safety, reliability and growth and enabling clean investments that are included in our $40 billion plus 10-year capital investment plan.
This investment profile should benefit our shareholders, our customers and the environment.
We see those opportunities weighted nearly 60% toward investments in our electric business throughout the plan.
While we are slightly behind the capital plan on a year-to-date basis, we are in the midst of ramping up to a sustained increase in our capital investments and we are restructuring contract crews in a way that helps support our labor needs to execute this level of investment.
We are confident we will make up the shortfall by early 2022.
Moving to the financing updates.
Our current liquidity remains strong at $1.8 billion, including available borrowings under our short-term credit facilities and unrestricted cash.
Our long-term FFO to debt objective remains between 14% and 15%, aligning with Moody's methodology and is consistent with the expectations of the rating agencies.
As mentioned during the Analyst Day, it's our intention to stay within this range throughout the course of our long-term plan.
Lastly, as we near the end of the calendar year, we are getting incrementally closer to the expected closing of the strategic transactions we've announced.
We recently filed a settlement in Arkansas that represents an agreement among all parties.
We anticipate that Arkansas Commission will issue its final approval by mid-December.
In Oklahoma, a hearing was held on November 3, and we expect a final order soon.
Finally, as Energy Transfer expressed on their earnings call earlier this week, the Enable and Energy Transfer merger is also expected to close before year-end.
Once that transaction closes, we will remain absolutely focused on reducing and then eliminating our exposure to midstream through a disciplined approach.
Analyst Day, we anticipate being fully exited from the midstream sector by the end of 2022.
We will then be nearly a pure-play regulated utility.
As we continue to express, we take our commitment to be good stewards of your investment very seriously and realize our obligation to optimize stakeholder value.
And with that, we look forward to more of these shorter earnings calls in the future.
As you heard from us today, and others from our full management team during the Analyst Day, the outlook for CenterPoint just keeps getting better.
As I said, we now have six quarters of meeting or exceeding expectations, but we believe there is much more to come.
We are demonstrating the pathway to premium, and we hope that you will be on board with us as a shareholder when that happens.
We will now take a few questions being mindful of today's earnings schedule and the upcoming EEI conference.
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q3 non-gaap earnings per share $0.33.
q3 earnings per share $0.32.
utility earnings per share guidance range for 2022 raised to $1.36 - $1.38.
reiterating 8% utility earnings per share annual growth rate target for 2022 through 2024.
raising 2021 non-gaap utility earnings per share guidance range to $1.26 - $1.28.
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Joining me are our President and Acting Chief Executive Officer, Joe Harvey; our Chief Financial Officer, Matt Stadler; and our Chief Investment Officer, Jon Cheigh.
Further, none of our statements constitute an offer to sell or the solicitation of an offer to buy the securities of any fund.
These non-GAAP financial measures should be read in conjunction with our GAAP results.
Before we go through our regular agenda, I'd like to provide an update on Bob Steers who as we announced in February is currently on medical leave.
Bob's recovery has been remarkable and he is doing well.
He is available to provide input on business decisions and we expect him to resume active duties as CEO by the end of the second quarter.
In the meantime, our executive committee and broader leadership group continue to perform at a high level.
I'll return later to summarize the quarter after Matt and Jon provide the reports.
Next up is Matt, who will review our financial results for the quarter.
Yesterday, we reported record earnings of $0.79 per share, compared with $0.61 in the prior year's quarter and $0.76 sequentially.
Revenue was a record $125.8 million for the quarter, compared with $105.8 million in the prior year's quarter and $116.6 million sequentially.
The increase in revenue from the fourth quarter was primarily attributable to higher average assets under management across all three investment vehicles, partially offset by two fewer days in the quarter.
Our implied effective fee rate was 57.3 basis points in the first quarter, compared with 57 basis points in the fourth quarter.
Excluding performance fees our fourth quarter implied effective fee rate would have been 56.3 basis points.
No performance fees were recorded in the first quarter.
Operating income was a record $53.2 million in the quarter, compared with $40.4 million in the prior year's quarter and $49.4 million sequentially.
Our operating margin decreased slightly to 42.3% from 42.4% last quarter.
The fourth quarter included a cumulative adjustment that reduced compensation and benefits to reflect actual incentive compensation that was paid, which increased our fourth quarter operating margin by 153 basis points.
Expenses increased to 8% compared with the fourth quarter, primarily due to higher compensation and benefits, distribution and service fees and G&A.
The compensation to revenue ratio for the first quarter was 35.5%, consistent with the guidance provided on our last call.
The increase in distribution and service fee expense was primarily due to higher average assets under management in US open-end funds.
And the increase in G&A was primarily due to higher professional and recruiting fees.
Our effective tax rate was 27.25% for the first quarter, in line with the guidance provided on last quarter's call.
Our firm liquidity totaled $118.8 million at quarter end, compared with $143 million last quarter.
Firm liquidity as of March 31 reflected the payment of bonuses as well as the firm's customary funding of payroll tax obligations, arising from the vesting and delivery of restricted stock units on behalf of participating employees.
We remain debt free.
Total assets under management was a record $87 billion at March 31, an increase of $7.1 billion or 9% from December 31.
The increase was due to net flows of $3.8 billion and market appreciation of $4 billion, partially offset by distributions of $690 million.
Advisory accounts which ended the quarter with a record $20.3 billion of assets under management, had record net inflows of $1.7 billion during the quarter.
$1.1 billion, of which were included in last quarter's pipeline.
We recorded $968 million of inflows from five new mandates and $799 million of inflows into existing accounts.
These inflows were evenly a portion between US real estate, global real estate, preferred and global listed infrastructure portfolios.
Joe Harvey, will provide an update on our institutional pipeline of awarded unfunded mandates.
Japan subadvisory had net outflows of $204 million during the quarter, compared with net inflows of $83 million during the fourth quarter.
We believe the outflows were largely attributable to a distribution rate cut made by the Japanese advisor to one of the funds we sub-advise in January 2021.
The last time the Japanese Advisor made a distribution rate cut to one of the funds we sub-advise was in the second quarter of 2019, which coincided with the last time Japanese Subadvisory had net outflows.
Encouragingly the annualized organic decay rate for the two months since January 2021 distribution rate cut was considerably less than what we experienced in 2019.
Subadvisory excluding Japan had net inflows of $97 million, primarily from the new Taiwanese mandate into a blended next-gen REIT digital infrastructure portfolio.
Open-end funds, which ended the quarter with a record $38.6 billion of assets under management had record net inflows of $2.2 billion during the quarter, primarily to US real estate and preferred funds.
Distributions totaled $238 million, $193 million of which was reinvested.
Let me briefly discuss a few items to consider for the second quarter and remainder of the year.
With respect to compensation and benefits, which includes the cost of our newly formed private real estate group that we announced earlier this week, we expect that our compensation to revenue ratio will remain at 35.5%.
We expect G&A to increase by about 9% from the $42.6 million we recorded in 2020, which is higher than where we guided to on our last call.
In addition to incremental investments in technology and global marketing, we expect an increase in recruitment costs associated with the hiring of certain key investment and distribution personnel in addition to the new private real estate group.
We expect that our effective tax rate will remain at 27.25%.
And finally, you will recall that on our last call, Bob Steers mentioned the termination of an institutional global real estate account of approximately $900 million that was expected to be withdrawn in the next quarter or two.
This account, which has a lower than average fee is still being managed and while we expect it to terminate this year, we have no visibility as to timing.
Today, I plan to review the investment environment, our performance and then provide some deeper perspective on our larger asset classes and their outlook.
So markets continued their strength in the first quarter as evidenced by US and global equities being up 6.2% and 4.7% respectively.
But beyond the noise, there were three noteworthy economic and market trend that stood out.
First, strong upward global growth revisions driven primarily by the US.
Second, underneath the surface, the market has increasingly taken on a reflationary tone as reflected by repricing of medium-term inflation prospects and a strong performance in our more inflation sensitive investment areas, such as commodities, which were up 6.9% for the quarter and are now up 35% over the last 12 months.
Last, with a higher growth and higher inflation as the context, we saw a repricing of Fed policy expectations, which partially drove the meaningful rise in the US 10-year treasury yield, ending the quarter at around 1.7%.
So given those three dominant trends of higher growth, inflation and rates, the high level summary of our asset class absolute performance is that listed real assets generally outperformed US and global equities.
This was led by MLPs, natural resource equities, and US REITs.
This performance was consistent with our expectations given deeply depressed relative valuations and that fundamentals for these asset classes were held disproportionately back in 2020 by the recession, but also some unique aspects from social distancing.
On the other side of the ledger, preferred securities were very modestly negative in the quarter.
Compression of preferred credit spreads could only partially offset the headwinds of the steep rise in yields.
That said, this flattish performance still far outpaced traditional fixed income in both income rate and total return with the Barclays Global Ag down 4.5%.
So turning to our performance scorecard.
In the first quarter six of nine core strategies outperformed their benchmark, but for the last 12 months seven of nine core strategies outperformed.
As measured by AUM, 93% of our portfolios are outperforming on a one-year basis, an improvement from 84% last quarter, mostly due to our preferred portfolios.
On a three and five year basis 99% and 100% respectively are outperforming, which is marginally better than last quarter.
By most medium and long-term measures, our investment performance continues to be strong and have high breadth.
That said the regime has shifted, particularly since the November of vaccine announcements.
We expect the market, which has been quite factor dominated to exhibit more idiosyncratic behavior over time, typically a more bottom up environment has allowed our specialist teams to achieve even higher performance batting averages.
So digging deeper into some of our major asset classes.
US and global real estate returned 8.3% and 5.8% respectively in the first quarter, both outpacing their respective equity indices.
Leadership has been in the Retail, Gaming, Lodging and residential areas in anticipation of significant pent-up demand supported by high global savings rates, driving multi-year recoveries in those areas.
The early phase -- the early cycle phase, excuse me, of an economy tends to be the strongest phase for listed real estate.
This is when economic recoveries are the strongest and where tightening is still several years away.
We continue to educate our clients by producing thought leadership demonstrating the historically higher growth and inflation expectations, triumps higher interest rates when it comes to reperformance.
Q1 absolute performance is a perfect reflection of that.
While we outperformed in our US and European strategies, our performance was weaker in Asia.
In general, while we have adopted a more value and reflationary repositioning in the US given stronger growth in vaccination success, we had been positioned more secularly in Asia given different growth dynamics.
Despite these different growth dynamics, Asia like the US has seen the value versus growth momentum reversal.
Preferred securities returned minus 0.6% in the first quarter and we outperformed in both our core and low duration preferred strategies.
After one quarter of underperformance last year, our highly experienced and accomplished team has now outperformed the last four quarters and 10 of the last 13 quarters.
We have also been communicating to our clients for the last three to six months that interest rates were more likely to move up over time, while the 10-year has trickled down since quarter-end, our expectation is that the 10-year will move more toward 2% by the end of 2021 and 2.25% by the end of 2022.
Importantly, in contrast to the start of the year, most market participants have already socialized the idea that rates will likely be higher over time, which in our view, reduces the odds of a tantrum or a disorderly unwind [Phonetic].
Given our rate view, we continue to suggest that investors consider our low duration preferred strategy when building portfolios.
Credit fundamentals of preferred issuers continues to improve with the economic recovery.
Take for instance US banks, who are the largest issuers of preferreds.
Banks have just come off an earning season in the US where they announced their releasing nearly $10 billion in loan loss reserves, as the pandemic-related losses they had accounted for have not been realized.
In addition their capital levels remain far in excess of their regulatory capital requirements.
The first quarter returned 3.5%, which slightly lagged global equities.
Returns in the quarter were led by economically sensitive businesses such as marine ports and freight railways and sustained higher energy prices provided a tailwind for midstream energy companies.
An important catalyst for the asset in the future will be infrastructure focused, fiscal stimulus packages around the world.
President Biden recently proposed over $2 trillion in spending and tax credits, which we see as a clear positive for listed infrastructure, tying into key themes we've highlighted over the past year.
Specifically, we see direct benefits for renewable energy developers in electric utilities, primarily through tax incentives.
We see the potential for new revenue opportunities for cell tower and data center companies, due to a larger addressable market for wireless carriers.
And last, we see broader support for the most economically sensitive segments of listed infrastructure, such as freight railways and marine ports.
Related, we continue to see increased adoption of infrastructure allocations with asset consultants and institutions, and we see growing interest from wealth advisors, as evidenced by record flows into our infrastructure open-end mutual fund and the NAV premium at which our infrastructure closed-end fund, UTF, continues to trade.
Disappointingly, we underperformed our benchmark during Q1 and while our three-year excess return is still attractive, we have underperformed over the last 12 months, so improving our performance here is a key focus area.
I also want to mention that our real assets multi-strategy portfolio was up 6.6% in the quarter, outpacing US and global equities.
We had very good relative performance of plus 100 basis points, with strong alpha contribution from asset allocation and natural resource equities.
We now have good relative performance over the last one, three and five years.
Over a full cycle, this portfolio is designed to provide equity like returns with inflation protection and with diversification versus stocks and bonds.
As a reminder, we launched this multi-strategy offering now more than nine years ago.
And in the last deflationary secular stagnation regime, it's fair to say, there wasn't much interest in diversified real assets.
Fast forward to today, it's clear that inflation is top of mind, while economic forecast always have wide confidence intervals, we expect that there is a very reasonable probability that inflation isn't just a short-term story, but it is more likely to be elevated for the long-term.
As a result, we expect that this is very good nine-year track record may be a hidden asset as we look out over the next three or five years.
And it's something we will speak about more on future calls.
We know that there is a fantastic opportunity to leverage the performance DNA in intellectual capital of our listed real estate team.
One with Jim's team, we are going to be able to create high performing stand-alone private strategies as well as integrated listed and private strategies that dynamically allocate over time to optimize for the best investment opportunities.
The start to 2021 couldn't have been more different than the start to 2020, as we begin to see the pathway out of the pandemic and toward economic recovery, rather than face the sea of uncertainty that the pandemic unleashed one year ago.
We're off to a good start in 2021.
Record fiscal and monetary stimulus combined with the continued rollout of vaccine distribution in the US have set the stage for reopening of our society and economy.
We expect this will be a gradual process and should result in a vigorous extended economic recovery.
Last year we achieved industry leading organic growth despite depreciation and share prices for REITs and infrastructure.
This year to date, we've had some catch-up appreciation, which has provided momentum to our results on top of our continued organic growth.
To set the stage for discussion of our fundamental trends, I'd like to share some thoughts on the big picture for our business and strategy.
Allocations to most of our asset classes are rising because of what I call the asset allocation dilemma.
That is fixed income yields cannot meet investors return targets, which places a significant ask on the equities portion of portfolios.
This creates a need for alternatives including real assets, which can provide equity like returns as well as diversification benefits.
This allocation dynamic combined with our strong investment performance has helped fuel our organic growth.
The current macro environment further supports the demand for our strategies.
Recently, Michael Hartnett, the Chief Investment Strategist at Bank of America, released a report citing five reasons to own real assets.
Number one, they're cheap and at the lowest valuations versus financial assets since 1925.
Number two, there are a hedge for inflation, infrastructure spending and the war against any quality.
Number three, they diversify portfolios.
Number four, they are under-owned and number five, they are scarce and more valuable in the coming digital currency era.
I believe that Hartnett's case for real assets only adds to the demand for our asset classes.
Turning to our fundamental results.
As Jon reviewed, we had an OK quarter in investment performance with six of nine core strategies outperforming as some portfolio managers didn't rotate strongly enough to value in cyclicality as the reopening rally unfolded.
We are confident in our investment teams ongoing portfolio adjustments.
Importantly with 93% and 99% of our AUM outperforming over one and three years respectively, we are in a terrific position to retain assets and compete for new allocations which continue at a good pace.
Our AUM set a record $87 billion at quarter-end with all three of our investment vehicles setting firm records.
Starting from a record $7.5 billion of gross inflows in the first quarter, firmwide net inflows were $3.8 billion and annualized growth rate of 19%.
Open-end funds led the way on net inflows with a record $2.2 billion, driven primarily by US REITs and secondarily by preferreds.
We were awarded $460 million asset allocation model placement in US REITs from a wealth advisory firm.
We also had multiple allocations from small to mid-sized institutions into our institutional US refund, in part driven by several new consultant recommendations.
Notwithstanding rising treasury yields, we had inflows into both our core and low duration preferred strategies, albeit with an anticipated shift and flow momentum to the low duration strategy.
Another notable open-end fund trend was a pickup inflows into our infrastructure fund.
We believe this increased interest has been driven in part by President Biden's infrastructure proposal as Jon mentioned.
In our major asset classes of Global real estate, US real estate, preferreds and infrastructure, we gained market share, measured against both active and passive fund vehicles combined, attribute to both our consistent performance and the strength of our distribution.
Institutional advisory had record net inflows of $1.7 billion.
We believe that the record results are partially attributable to attractive relative valuations and allocation entry points for real estate and infrastructure as well as the strong execution by our distribution team in the Middle East where we've seen growing demand for real estate and infrastructure strategies.
Subadvisory ex-Japan had net inflows of $97 million, relatively quiet, but importantly included a mandate combining two of our recently developed strategies.
Japan subadvisory was our only channel with net outflows, primarily due to one funds distribution reduction that Matt explained.
For perspective, Japan subadvisory peaked in the third quarter of 2011 at 33% of our AUM, but is now just 11% of our AUM as assets have declined by 34% in Japan, while the firm's AUM and other channels has grown by 69%.
Our current won unfunded pipeline stands at $1.4 billion.
Working from last quarter's $1.8 billion pipeline, we had $1.1 billion of fundings in the quarter and won $940 million in seven new mandates and account top-ups across global real estate, infrastructure and a multi-strategy blend of US REITs and preferreds.
Three of the seven new mandates were in our focus strategies, which have higher active share and where performance has been very strong.
We continue to see growing interest for these differentiated, high-performing strategies.
Turning to corporate strategy.
We are confident and continuing to invest in the business.
We believe the next several years will be good allocation entry points for both real estate and infrastructure, providing additional support for resource allocation.
Priorities always start with alpha generation, so we will continue to invest in people, process, data and strategy development.
On that front, we continue to allocate resources to next-generation strategies, focused portfolios, multi-strategy allocation capabilities, ESG integration, and as we announced earlier this week, expanding our real estate capabilities.
Our strategic rationale is to create another growth driver through private investment in the $15 trillion universe of real estate in the US that is not owned by listed REITs.
Leading the group is Jim Corl, who previously worked with us from 1997 to 2008, in his last four years as Chief Investment Officer of our listed real estate team.
Jim spent the last 11 years at Siguler Guff & Company, where he helped build and led an opportunistic real estate investment business.
We're excited about the team that Jim has built to execute our private business, which is a testament to Jim and to our platform.
Without distractions from legacy assets, this team will be able to focus on the best investment opportunities available today.
Our goal is to excel in private real estate as a stand-alone as we haven't listed -- but more importantly, to innovate in combining listed and private to create more alpha levers.
Investors have become more interested and agile in allocating between the two markets.
Moreover, many institutions have real estate allocations that are heavily weighted in legacy property types such as office and retail.
As a result, they need new solutions, and we believe we are well positioned to provide advice on how to rebalance using the listed markets or segments of the private market.
These dynamics will position us to gain a greater share of real estate allocations, where private typically has the greatest share.
We have a product plan that includes strategies and vehicles for both the institutional and wealth channels.
Bob Steers's and my collective vision is to have both private and listed capabilities in real estate and infrastructure, enabling us to provide stand-alone strategies and bespoke solutions that include both markets.
We will work closely with Greg Bottjer, who heads Product Strategy, as well as our Executive Committee to build this foundation for our next phase of growth.
In conclusion, while the past year has been unprecedented, we are energized and optimistic about our future.
We look forward to returning to the office and seeing our colleagues and all of you in person.
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qtrly net inflows of $3.8 billion.
qtrly adjusted earnings per share $0.79.
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Joining me are our Chief Executive Officer, Bob Steers; our President, Joe Harvey; and our Chief Financial Officer, Matt Stadler.
Further, none of our statements constitute an offer to sell or the solicitation of an offer to buy the securities of any fund.
These non-GAAP financial measures should be read in conjunction with our GAAP results.
Yesterday, we reported record earnings of $0.94 per share compared with $0.54 in the prior year's quarter and $0.79 sequentially.
Revenue was a record $144.4 million for the quarter compared with $94 million in the prior year's quarter and $125.8 million sequentially.
The increase in revenue from the first quarter was primarily attributable to higher average assets under management across all three investment vehicles, the recognition of performance fees and one additional day in the quarter.
Our implied effective fee rate was 58 basis points in the second quarter compared with 57.3 basis points in the first quarter.
Excluding performance fees, our second quarter implied effective fee rate would have been 57 basis points.
No performance fees were recorded in the first quarter.
Operating income was a record $62.6 million in the quarter compared with $35.5 million in the prior year's quarter and $53.2 million sequentially.
Our operating margin increased to 43.4% from 42.3% last quarter.
The second quarter included a cumulative adjustment to reduce the compensation to revenue ratio.
Expenses increased 12.6% compared with the first quarter, primarily due to higher compensation and benefits, distribution and service fees and G&A.
The compensation to revenue ratio, which included the just mentioned cumulative adjustments to lower the incentive compensation accrual, was 35.03% for the second quarter and is now 35.25% for the six months ended.
The increase in distribution and service fee expense was primarily due to higher average assets under management in US open-end funds, and the increase in G&A was primarily due to higher professional and recruitment fees as well as an increase in travel and entertainment expenses.
Our effective tax rate, which also included a cumulative adjustment, was 26.51% for the second quarter and is now 26.85% for the six months ended.
The reduction in the effective tax rate from the first quarter was primarily due to the diminished effect of the non-deductible portion of executive compensation on a higher than previously forecasted pre-tax base.
Our firm liquidity totaled $185.6 million at quarter-end compared with $124.3 million last quarter.
Total assets under management was a record $96.2 billion at June 30th, an increase of $9.2 billion or 11% from March 31st.
The increase was due to net inflows of $2.6 billion and market appreciation of $7.4 billion, partially offset by distributions of $769 million.
Advisory accounts, which ended the quarter with a record $23.1 billion of assets under management, had net inflows of $1 billion during the quarter.
We recorded $300 million of inflows from five new mandates and a record $1.2 billion of inflows from existing accounts.
Partially offsetting these inflows were $493 million of outflows resulting from client rebalancing.
Net inflows were evenly a portion between US real estate, Global real estate, Preferred and Global listed infrastructure portfolios.
Bob Steers will provide an update on our institutional pipeline of awarded unfunded mandates.
Japan Subadvisory had net outflows of $272 million during the quarter, compared with net outflows of $204 million during the first quarter.
As mentioned on last quarter's call, in January of 2021, our distribution rate cut was made to one of the funds we subadvised.
Encouragingly the rate of net outflows in this fund decelerated throughout the quarter and we actually recorded net inflows for the month of June.
Subadvisory excluding Japan had net outflows of $375 million primarily from a single client who decided to bring the portfolio management for a portion of the assets we manage for them in-house.
Open-end funds, which ended the quarter with record assets under management of $43.5 billion, had net inflows of $2.1 billion during the quarter.
This marks the 10th straight quarter of net inflows into open-end funds, and the first time we have recorded net inflows into each of our 11 US mutual funds.
Net inflows were primarily into US real estate and preferred funds.
Distributions totaled $312 million, $260 million of which was reinvested.
Let me briefly discuss a few items to consider for the second half of the year.
With respect to our outlook for compensation, the double-digit sequential growth in our assets under management and revenue, driven by our industry-leading organic growth rate and our strong investment performance, is tempered by the fact we still have half a year ago.
As a result, we reduced the compensation to revenue ratio by 25 basis points to 35.25% for the six months ended, and we expect that our compensation to revenue ratio will remain at 35.25%.
As we resume certain business activities that have been restricted during the worst of the pandemic, we expect G&A will increase by about 12% from the $42.6 million we recorded in 2020, but only by about 3% from the $46 million we recorded in 2019.
As was the case last quarter, the increase is primarily attributable to incremental investments in technology and global marketing as well as higher recruitment costs associated with the hiring of certain key investment and distribution personnel.
We expect that our effective tax rate will remain at 26.85%.
And finally, during the second quarter, in response to a client requests, we converted the fee structure on two portfolios from a performance-based fee structure to a base fee-only.
This conversion resulted in the realization of the year-to-date outperformance.
The increase in the base fee for these portfolios is not expected to have a meaningful impact on our overall effective fee rate.
Today, I will review our investment performance and discuss related key themes such as our near record, our perfect record of outperformance, what we are doing to sustain and enhance performance, the impact of accelerating inflation on our asset classes and how our major asset classes are performing versus expectations at the beginning of the year.
As we all know, in the second quarter, the US economy reopened from the pandemic and surged powerfully, driving appreciation and positive returns in virtually all asset classes.
A good portion of our AUM did better than the S&P 500, which was up 8.6%.
And we continued to post stellar outperformance versus our benchmarks.
One surprising development was that, treasury yields declined in the quarter against the backdrop of accelerating economic growth and rising inflation.
In fact, inflation surprised on the upside, something that hasn't happened in a long time.
Looking at our performance scorecard, in the second quarter, eight of nine core strategies outperformed their benchmarks.
For the last 12 months, all nine core strategies outperformed.
99% of our AUM is outperforming benchmarks on a one-year basis compared with 93% last quarter, driven by improvements in global listed infrastructure and certain global real estate portfolios.
On a three-year basis 100% of AUM is outperforming, and for five years 99% is outperforming, essentially the same as last quarter.
US REITs returned 12% in the quarter, lifting the year-to-date return to 21.3%.
We outperformed our benchmark in the quarter and for the last 12 months.
Going into this year, we believe 2021 would be a good, so called vintage year for real estate investing starting first with listed and then followed by private, consistent with a long history of the listed market leading the way, particularly during turning points.
The reopening in the US economy has created greater visibility into the turnarounds and demand for space, leasing activity and tenant credit and assorting out of rent deferrals, all of which restrained REIT share prices last year, while investment sales activity resumed including some major portfolio and Company sales.
While fundamentals and share prices for many property sectors have reached or eclipsed pre-pandemic levels, some of the most impacted sectors such as hotels, office and healthcare have loan recovery runways.
We believe that inflation in prices for building materials, such as steel and copper, labor, housing and land have contributed to rising real estate values and share prices.
This is different than in past periods where the replacement cost dynamic has taken a development cycle to kick in.
Global real estate returned 9.2% in the quarter compared with global stocks at 7.7%, lifting the year-to-date return to 15.5%.
For both the quarter and the last 12 months, we have outperformed in all three of our regional strategies as well as in our global and international strategies.
Global listed infrastructure returned 2.9% in the quarter, lifting the year-to-date return to 7%.
We outperformed for the quarter and for the last 12 months.
Similar to real estate, we believed that 2021 would be a good vintage year for infrastructure investing as infrastructure depreciated last year in part due to the sub-sectors that were uniquely impacted by the pandemic.
This year, the sectors hardest hit by the pandemic such as airports, ports and toll roads are still wrestling with concerns about the spread of coronavirus variance and levels of cross-border travel.
And utilities have been flat for the second year in a row, left back in a strong technology-led bull market.
That infrastructure performance, while positive, has not been stronger likely represents an opportunity in our view.
Preferred returned 2.9% in the quarter, helped by the 10-year treasury yield falling 30 basis points to 1.4%.
The year-to-date return is 2.4%.
We outperformed in the quarter and for the last 12 months in both our core and low duration preferred strategies.
Going into this year, we believe that the flat yield curve with the potential for a transition in the rate environment to higher long-term yields suggested investors should pivot toward our low duration strategy.
Notwithstanding the surprise and inflation this year, concerns about the coronavirus variants and global central bank yield management, have resulted in a very orderly interest rate market.
The risks of higher bond yields are on our watch list.
The inflation surprise has helped some of our strategies performance wise and has stimulated investor demand, particularly in our real estate strategies.
Going into this year we believe that inflation risks arising and that our multi-strategy real assets portfolio would see greater investor interest, while conversations have increased, they have yet to translate into flows.
Our real assets multi-strategy benchmark returned 8.5% in the quarter, lifting the year-to-date return to 14.5%.
We outperformed for both the quarter and the last 12 months, driven by excess returns in every strategy sleeve, real estate, infrastructure, commodities, resource equities, gold and high-grade low duration credit, and through top down asset allocation.
In the quarter commodities returned 13.3%, with 25 of the 27 commodities in the index producing positive spot price returns.
On the topic of whether higher inflation is temporary or not, we believe that many factors, including unprecedented fiscal and monetary stimulus, trade bottlenecks, labor markets, housing prices and consumer psychology have come together to support a phase of higher and longer inflation.
If so, the conversations about inflation solutions should turn into more allocations.
In terms of inflation beta or the sensitivity to surprise inflation, the most sensitive of our strategies in descending order are commodities, resource equities, multi-strategy real assets, infrastructure and real estate.
At the same time, the macro environment for real assets is improving.
Real assets are the cheapest versus equities in nearly 20 years.
While we have a near-perfect record of outperformance, we are by no means complacent.
Our goal is to sustain our current level of outperformance, while continuing to innovate, identify alpha sources, put process in place to harvest that alpha and widen our excess return margins versus benchmarks.
The longer our outperformance persist, the better our ability to realize returns on the investments we've made and new vehicles and distribution.
We continue to devote resources to our investment department.
We've talked previously about our initiatives to integrate quantitative techniques and IT efficiencies into our fundamental processes.
Those initiatives are producing positive results and our investment teams are now asking for more.
We've added analysts and are identifying our next group of emerging leaders through our annual talent review process.
We recently added a Head of ESG, who will help our teams take our current ESG integration framework to the next level, contribute to the development of explicit strategies and help address the increasing demands of clients and consultants.
We see many opportunities for innovation and real estate investing.
There is an acute need for next generation real estate strategies to help investors reorganize and rebalance existing allocations, which are heavy in private, heavy in core property types and are not set up to be nimble to pivot to where the best deal is.
We have developed next generation, new economy property type strategies for the listed market.
In April, as we discussed on the last call, we announced the formation of our Private Real Estate group.
Our imperative is to innovate at the intersection of private and listed real estate investing to tilt to where the best returns are and harvest the alphas at those intersections.
Meantime, the pandemic has created change in demographic and business trends, which we believe creates opportunity by geographic market, property sector and business model.
Our private team is organized, our allocation and research processes between listed and private are established and we are commencing efforts to raise capital in institutional vehicles and in closed-end fund strategies.
In closing, we are in a unique phase of the economic and market cycles from an investor's perspective or what we do.
The setup that I've talked about before is how to achieve in a risk-managed fashion, a return bogey of 7% from a 60-40 blend of stocks and bonds.
For a long while now, the 40% in fixed income on a current basis has not been able to meet the return goal.
Now introduce inflation and the exercise becomes more difficult.
The fixed income dilemma is tougher.
There is higher risk for equities and the need to fit real assets into portfolios is greater.
Our strategies offer attractive total returns, current yield, diversification, inflation protection and for the taxable investor, tax advantages.
We have organized our teams to engage with clients to help solve these portfolio challenges.
We are excited about the opportunity.
First off, it's great to be back at work in my office, and I'm 100% healthy.
Also, I'd like to recognize Joe Harvey and our entire Executive Committee, who stepped up seamlessly in my absence, which underscores the quality and depth of our leadership team.
As I look back on the quarter and the year-to-date, it's apparent that we're in an environment that's very favorable for real assets.
The historically strong cyclical recovery that we've experienced this year has fostered a dramatic rebound in fundamentals for real assets ranging from real estate and infrastructure to resource equities and commodities.
The rebound and prospects for real assets versus 2020 is stark.
As Joe just pointed out, whereas the performance of virtually all real asset strategies badly lagged the broader equity markets last year, the reverse has been the case so far this year, especially for our real estate and diversified real asset strategies.
We believe this is a unique point in time for real assets and CNS, one that will not be transient in nature, and is supported by secular trends.
First, this cyclical recovery is historic and underpinned by unprecedented fiscal and monetary stimuli, which are supportive of real asset fundamentals.
Second, investor psychology is shifting toward real assets.
The forces behind this shift are both fundamentals, including growing demand for hedges against unexpected inflation, and technical also including expectations of massive capital flows into public and private infrastructure.
We believe our strong brand and investment performance have put us in a unique position to capitalize on these trends as evidenced by our $2.6 billion in net inflows and the 12% organic growth in this latest quarter.
That said, we're working hard to expand our breadth and depth of capabilities in the real asset space by developing unique and valuable new space [Phonetic].
In addition, we're continuing our work to enhance and improve the results in all distribution channels, especially our US Advisory segment.
Last quarter's net flows in the wealth channel were a near-record $2.1 billion, and just shy of the first quarter record of $2.2 billion.
The organic growth rate in this, our largest channel was 22%.
Importantly, the strong growth in assets was well diversified by channel and product.
We saw strong flows for each of the broker dealer, RIA and independent channels.
DCIO also delivered a $163 million of net inflows, which marks the 12th consecutive quarter of positive net flows for this vertical.
Flows by strategy were diverse as well.
The preferred securities fund led the way with $665 million of net inflows, and our low duration preferred securities fund also generated $205 million of net inflows.
Consistent with the growing interest in real estate, our global real estate securities fund achieved a record $370 million of net inflows in the quarter, and year-to-date has generated a 62% organic growth rate.
Net flows into our three US real estate funds were strong as well at $390 million.
Our non-US funds experienced $61 million of net inflows, which marks the fourth consecutive quarter of positive inflows.
These flows, which have been accelerating, are the result of our expanding network of platforms and relationships throughout the EMEA region.
We expect these results will continue to improve over time.
The advisory channel delivered a solid $1 billion of net inflows in the quarter, also with strong demand across a range of strategies.
US real estate led the way with $443 million of net inflows, followed by preferred securities at $314 million.
Global real estate and global infrastructure also experienced net inflows of $227 million and $162 million, respectively.
$860 million of the $1.4 billion beginning institutional pipeline was funded during the quarter.
In addition, $479 million of new mandates was both won and funded in the quarter, and thus, never even made it into the pipeline.
Our end of quarter pipeline stands at $925 million.
As you may remember, less than one year ago, the advisory group under the leadership of Jeff Sharon was reorganized into a regional team approach, and we are very encouraged by these early results.
The subadvisory channel had net outflows of $375 million, which was attributable to one client who took $381 million of US and global real estate mandates in-house as a cost-saving measure.
Similarly, Japan subadvisory saw $272 million of net outflows, and $309 million of distributions, which reflect the continuing effects of a distribution cut in a large US REIT fund.
Looking ahead, the economy and equity markets appear to be at a tipping point, either the economic activity slows materially and inflation pressures turn out to be transitory or not.
As Joe alluded, the indicators that we follow strongly suggest that economic activity and inflation will remain higher for longer than expected.
In this environment, real assets will be highly sought after for their return and diversification characteristics.
Current fundamentals and stock market momentum appear to confirm this view.
We believe that this is a time to step-up new product initiatives to capitalize on what we expect will be strong vintage years ahead of us.
The launch of our first private real estate fund will be an important milestone for us.
Related to this, we are also growing our multi-strat asset allocation team.
And this, together with our listed and unlisted capabilities, will position us at the intersection of what is now for us a $16 trillion real estate universe.
The opportunity as we see it is to advise investors on how to tilt their real estate portfolios between listed and unlisted investments continuously to generate alpha and maximize returns.
This will open a range of opportunities for us from open and closed-end funds and separate accounts to non-traded vehicles.
Separately, we expect to recognize improved results from our EMEA, wholesale and US institutional teams, both of which are benefiting from new leadership and additional resources.
Only time will tell, but our excellent track record, strong cyclical tailwinds and proven distribution make us as excited about our growth prospects as ever.
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qtrly diluted earnings per share of $0.95; $0.94, as adjusted.
quarter ending aum of $96.2 billion; average aum of $92.9 billion.
qtrly net inflows of $2.6 billion.
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Joining me are our Chief Executive Officer, Bob Steers; our President, Joe Harvey; and our Chief Financial Officer, Matt Stadler.
Further, none of our statements constitute an offer to sell or the solicitation of an offer to buy the securities of any fund.
These non-GAAP financial measures should be read in conjunction with our GAAP results.
Yesterday, we reported record earnings of $1.06 a share compared with $0.67 in the prior year's quarter and $0.94 sequentially.
Revenue was a record $154.3 million for the quarter compared with $111.4 million in the prior year's quarter and $144.4 million sequentially.
The increase in revenue from the second quarter was primarily attributable to higher average assets under management across all three investment vehicles and one additional day in the quarter, partially offset by a sequential decline in performance fees from certain institutional accounts.
Our implied effective fee rate was 57.5 basis points in the third quarter compared with 58 basis points in the second quarter.
Excluding performance fees, our third quarter implied effective fee rate would have been 57.3 basis points compared with 57 basis points in the second quarter.
Operating income was a record $70.4 million in the third quarter compared with $44.2 million in the prior year's quarter and $62.6 million sequentially; and our operating margin increased to a record 45.6% from 43.4% last quarter.
Expenses increased 2.6% compared with the second quarter, primarily due to higher compensation and benefits, distribution and service fees and G&A.
The compensation to revenue ratio, which included a cumulative adjustment to lower the incentive compensation accrual was 33.19% for the third quarter and is now 34.5% for the trailing nine months.
The increase in expenses related to distribution and service fees was primarily due to higher average assets under management in U.S. open-end funds, partially offset by a favorable change in share class mix.
And the increase in G&A was primarily due to higher travel and entertainment expenses as well as costs attributable to preparation for a new closed-end fund that combines public and private real estate with preferred and debt securities.
Our effective tax rate, which was 25.93% for the quarter, included a cumulative adjustment to bring the rate to 26.5% for the trailing nine months.
The reduction in the effective tax rate from the second quarter was primarily due to the diminished effect of the non-deductible portion of executive compensation on a higher than previously forecasted pre-tax base.
Our firm liquidity totaled $241 million at quarter-end compared with $185.6 million last quarter and we continued to be debt free.
Total assets under management were $97.3 billion at September 30, an increase of $1 billion or 1% from June 30.
The increase was due to net inflows of $1.3 billion and market appreciation of $469 million, partially offset by distributions of $718 million.
This marks our ninth straight quarter of net inflows.
Advisory accounts, which ended the quarter with $22.8 billion of assets under management had net outflows of $311 million during the quarter.
We recorded $1.1 billion of inflows, the majority of which were from existing accounts.
Offsetting these inflows were $1 billion of outflows from an unexpected account termination after a client decided to eliminate its allocation to multi-start real assets as well as $300 million of client rebalancings.
This account termination is unrelated to the one noted on previous calls.
Bob Steers will provide an update on our institutional pipeline of awarded unfunded mandates.
Japan Subadvisory had net outflows of $52 million during the quarter, compared with net outflows of $272 million during the second quarter.
Distributions from these portfolios totaled $295 million compared with $309 million last quarter.
Subadvisory, excluding Japan, had net outflows of $253 million, primarily from a client that decided to convert its global listed infrastructure portfolio to passive.
Open-end funds, which ended the quarter with a record $45.6 billion of assets under management had net inflows of $2 billion during the quarter.
Net inflows were primarily into U.S. real estate and preferred funds.
Distributions totaled $276 million, $225 million of which was reinvested.
Let me briefly discuss a few items to consider for the fourth quarter.
With respect to compensation, we continue to refine our estimates as we approach year-end.
Given our double-digit year-over-year growth in assets under management, revenue and operating income, driven by our leading organic growth and strong investment performance, we reduced the compensation to revenue ratio from the previous quarter's guidance of 35.25% by 75 basis points to 34.5%.
All things being equal, we expect our compensation to revenue ratio for the fourth quarter to remain at 34.5%.
We now project that our G&A will increase by about 9% from the $42.6 million we recorded in 2020.
And finally, we expect that our effective tax rate will remain at approximately 26.5%.
Today, I will review our investment performance, discuss the macro environment and its impact on our asset classes and talk about certain key priorities for our investment department.
The third quarter felt like a transitory phase in the markets with the S&P 500 up 0.6% and low dispersion across sub-sector performance.
The markets are evaluating several important macro shifts, including stabilization of virus trends after the variant scares, deceleration in the economic recovery, potential for a transition from monetary easing to tightening and gridlock in Washington DC regarding stimulus and potential tax increases.
The one trend that continued to gain traction was the likelihood that inflation will be more persistent.
Reflecting that, commodities reached a seven-year high and were up 7% in the quarter, one of the top-performing asset classes.
The commodities rally has been broad-based with spot prices positive year-to-date for 80% of commodities.
Looking at our performance scorecard, in the third quarter and for the last 12 months, eight of nine core strategies outperformed their benchmarks.
International real estate, which is global ex-U.S. was the one strategy that underperformed for both time periods.
Measured by AUM, 79% of our portfolios are outperforming benchmarks on a one-year basis compared with 99% last quarter.
On a three and five-year basis, 100% of AUM is outperforming.
The one-year figure declined primarily due to global real estate, where our batting average declined from 99% last quarter to 25% in Q3.
Our core global real estate accounts are outperforming year-to-date.
So if we at least break even in the fourth quarter, our figures will improve next quarter.
We believe the macro environment is favorable for most of our strategies in terms of both fundamentals and investor demand.
We expect above trend economic expansion and more persistent inflation.
If the pandemic continues to subside and the recovery broadens, some of the most negatively affected sub-sectors in real estate and infrastructure should continue to recover and help sustain the fundamental recovery.
In terms of investor demand, the need for income is acute as is the need for equity-like returns with diversification.
Adding inflation to the picture should increase demand for more of our strategies.
As we said last quarter, our reading of the factors contributing to inflation supports a phase of higher for longer inflation.
U.S. real estate returned 0.2% in the quarter and we outperformed in all of our sub strategies.
Year-to-date, U.S. real estate is up 21.6%, outperforming the S&P 500's 15.9%.
The powerful recovery in real estate security prices has been driven by a return of overall demand and increased market need for effective inflation hedges and the ongoing search for income.
So far in 2021, $13 billion has flowed into REIT, mutual funds and ETFs, the largest inflow since 2014.
We continue to see increased adoption of listed REITs by institutional investors as a core component of their real estate allocations.
Investors better understand and can tolerate short-term volatility, knowing that over the long-term, REITs are highly correlated to the fundamentals of their underlying real estate.
And the long-term record of listed REITs compared with core private real estate is undeniably compelling.
REITs have outperformed by nearly 400 basis points annually for over 40 years, while providing liquidity.
These dynamics are powerful in terms of potential flows as REIT allocations get right-sized higher based on merit.
Global real estate returned negative 0.7% in the quarter.
While our core strategies outperformed slightly, our international strategy underperformed, primarily due to the Asia sleeve of our portfolios.
Global listed infrastructure returned negative 0.25% in the quarter and we outperformed in all of our sub-strategies.
The downward trajectory of the virus spread and return of travel and global commerce has made marine ports and airports some of the best performing sectors in the quarter.
The big news for infrastructure was what didn't happen that being passage of infrastructure legislation in Washington, DC.
The longer the process takes, the more it underscores the need for infrastructure capital investment and generates interest in the asset class.
Institutionally, infrastructure as an asset class is understood and accepted, and we see strong search activity.
The dry powder amassed by private equity infrastructure managers reached a record $300 billion and provides fuel for our investment thesis that private equity capital will find its way into the listed markets to buy companies and assets with the latest example being the announced privatization of Sydney airport.
In terms of the wealth channel, we need to continue to educate on how infrastructure best fits into allocation strategies.
Notwithstanding that, we've seen strong inflows into our open-end infrastructure fund in part based on the headlines related to significant infrastructure spending.
Preferred securities returned 0.6% for our core strategy and 0.2% for our low duration strategy.
We outperformed in both.
Preferreds continue to look attractive in the fixed income world with yields of 4.8% for investment-grade preferreds in our core strategy and 4.2% for our low duration strategy.
For context, corporate bonds yield 2.25%, municipals yield 1.75% and high-yield yields 4.75%.
Our portfolios are positioned defensively relative to interest rates and we continue to guide incremental allocations to our low duration strategy, which by design has a duration of less than three years and is the only one of its kind.
The benchmark for our multi-strategy real assets portfolio returned 1% in the quarter and we outperformed.
As a reminder, this strategy combines real estate, infrastructure, commodities, resource equities, gold and short duration credit with an asset allocation overlay.
Over the past year, the real assets portfolio returned 32.5% compared with the S&P 500 at 30%.
This strategy is designed to provide protection from unexpected inflation and produce equity-like returns with a low correlation to financial assets.
Somewhat surprisingly, we haven't seen a significant increase in demand for this portfolio, but with a long history of head fakes on inflation, it simply may be early and the demand for this strategy may follow rather than lead inflation.
We continue to expand our investment department, including the addition of a Portfolio Manager and Head of Multi-Asset Solutions, who will join us next month to oversee asset allocation, strategy research and macroeconomic research.
This is a strategic role that will expand our real assets and real estate solution investment capabilities and enable us to engage with clients at a higher level.
We've made tremendous progress preparing strategies for our private real estate business, including a strategy with a capital appreciation objective.
We have commenced the investment process and are evaluating acquisition opportunities.
In addition, for our closed-end real estate funds, we will pursue an income strategy to capitalize on mispriced property sectors.
This will expand our investment universe for our closed-end funds and supplement these funds' primary focus on listed real estate with higher income generation and rifle shot opportunities in the private market.
These are examples of our broader vision using both listed and private real estate to broaden our opportunity sets and provide investors with optimized allocations to real estate by tilting portfolios to where the best values are.
Looking into 2022, we will be developing other vehicles for the wealth channel and we expect to add a real estate strategist to further enhance our asset allocation and advisory capabilities.
Meantime, commercial real estate has a positive outlook with fundamentals strong or recovering, compelling income generation, and particularly in this environment, attractive inflation sensitivity.
Finally, we're looking forward to the next phase of our return to office plan whereby everyone will be in the office three days a week beginning next week.
While we have performed well working remotely as our operations and investment performance attest, we want to get back to in-person interaction, debate and decision-making on the investment team and across the firm.
The creativity, innovation and cross-team collaboration our business requires is best done in person.
Current indicators point to the general containment of the pandemic, thereby allowing us to return safely as we transition to being together once again as a team while having the best of both worlds with some work model flexibility.
As you heard from Matt and Joe, we had a very strong quarter.
Continued excellent investment performance across the board, record AUM, revenues, earnings and profit margins.
For the first time in several years, we benefited from strong, absolute and relative market returns.
We believe this is significant because fundamentals indicate that this is the beginning of a new trend, not the end.
An inside joke here at Cohen & Steers is how often I use the metaphor of how important it is to skate to where the puck will be and not stare at where it is now.
Where the puck is now is only useful in helping to see where it's going.
Broad-based, demand-driven inflation will persist and is most definitely not transient, but the bond market, like most investor portfolios is where the puck was.
The latest inflation measures have all moved broadly higher.
September CPI increased 5.4% year-over-year and the core CPI was also up 4%.
In a surprise announcement, the Social Security Administration last week disclosed that future payments will be increased by 5.9%, the largest such increase in over 40 years.
Consumer spending surged 11.9% in the second quarter and 13.9% in the month of September.
But the real story beyond these surging spot indicators is the steady increase of the more persistent and heavily weighted components of these inflation measures.
Rent is a key category as it makes up over 30% of CPI.
Tenant rent jumped 0.5% in September which was the biggest monthly increase in 20 years.
Owners' equivalent rent, which is the accepted measure of what homeowners would pay if they had to rent their homes rose 0.4%, the most since 2006.
Lastly, as these persistent measures of inflation continue to rise, it can cause expectations to become self-fulfilling.
According to the New York Fed, consumers' median inflation expectations for the next three years is 4.2%.
So where the puck is today isn't bad as we saw this quarter, but to get to where the puck is going, will require investors to reposition their portfolios to hedge against or even benefit from the shift to a more enduring inflationary environment.
All real asset classes and especially infrastructure and real estate have historically provided investors with the solutions that they'll be looking for.
At the risk of being repetitive and with the benefit of strong, absolute and relative returns from our real asset strategies, we achieved record AUM of $97.3 billion and over $100 billion intra-quarter; record open-end fund AUM of $45.6 billion and $1.3 billion of net inflows in the quarter.
As has been the case, recently, the wealth channel led the way with $2 billion of net inflows, representing 18% organic growth and our third best quarter on record.
Both the BD and RIA verticals were strong and DCIO fund flows were positive for the 13th straight quarter.
From a product standpoint, we saw strength in preferred security strategies, which generated net inflows of $1.1 billion, and in real estate which had net inflows of $755 million.
Looking forward, as inflation and interest rates move higher, we anticipate that flows into our low duration infrastructure and multi-strategy real asset portfolios will all benefit.
In addition, we have filed with the SEC to launch a closed-end fund offering in the first quarter of next year that will combine public and private real estate in one actively managed listed portfolio.
In the advisory channel, due to a planned design change, we had an unexpected $1 billion termination of a high performing multi-strategy real asset portfolio, which resulted in $311 million of net outflows in the quarter.
Gross inflows remained strong, totaling $1.1 billion with U.S. real estate accounting for over two-thirds of that amount.
The pipeline of awarded but unfunded mandates is at $900 million and we recorded $550 million of mandates, which were both won and funded in the quarter, our second best result on record.
Japan Subadvisory net outflows were $52 million pre-distributions and totaled $347 million, including distributions.
All things being equal, we are optimistic that flows, especially for our U.S. real estate portfolios, may shortly begin to improve.
First, the portfolios are performing extremely well, especially after currency adjustments.
Second, we are approaching the 12-month mark for the last distribution cut, which typically coincides with flows turning positive.
Lastly, the end of COVID restrictions -- with the end of COVID restrictions in Japan, our teams have been asked to resume a significant number of in-person sales seminars.
Subadvisory ex-Japan had net outflows of $253 million as well, primarily driven by the termination of an offshore global listed infrastructure portfolio and modest outflows elsewhere.
We did bring on a new $83 million global real estate mandate in the quarter.
We believe that the next several years will witness a generational shift in the economy and capital markets.
Higher growth rates sustained by unprecedented monetary and fiscal stimuli have produced demand-driven supply/demand imbalances resulting in asset price inflation, which is becoming self-fulfilling.
Real estate values and rents, labor costs and commodity prices are rising with no current end in sight.
Many investors have never experienced this set of economic variables.
We believe that as investors begin to extrapolate these trends, allocations to real assets, especially infrastructure and real estate will substantially increase.
Our traditional range of products is well positioned to capture this shift.
In addition, we recently commenced the marketing process for our private real estate strategies that we discussed last quarter.
And as I've said, we hope to launch our first public-private real estate closed-end fund this February.
Given the favorable outlook for real assets, we are committed to adding new capabilities and products that will provide the solutions that investors need when they ultimately see where the puck is going.
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cohen & steers inc - qtrly diluted earnings per share of $1.05; $1.06, as adjusted.
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Joining me are our Chief Executive Officer, Bob Steers; our President, Joe Harvey; and our Chief Financial Officer, Matt Stadler.
Further, none of our statements constitute an offer to sell or the solicitation of an offer to buy the securities of any fund.
These non-GAAP financial measures should be read in conjunction with our GAAP results.
Yesterday, we reported record earnings of $0.76 per share compared with $0.74 in the prior year's quarter and $0.67 sequentially.
The fourth quarter of 2020 included cumulative adjustments to compensation and benefits and income taxes that lowered our compensation to revenue ratio and effective tax rate, respectively.
Revenue was a record $116.6 million for the quarter compared with $109.8 million in the prior year's quarter and $111.4 million sequentially.
The increase in revenue from the third quarter was primarily attributable to higher average assets under management, partially offset by lower performance fees when compared with the third quarter.
Our implied effective fee rate was 57 basis points in the fourth quarter compared with 59 basis points in the third quarter.
Excluding performance fees, our fourth quarter implied effective fee rate would have been 56.3 basis points, and our third quarter implied effective fee rate would have been five point -- 56 basis points.
Operating income was a record $49.4 million in the quarter compared with $47.4 million in the prior year's quarter and $44.2 million sequentially.
Our operating margin increased to 42.4% from 39.6% last quarter.
Expenses were essentially flat compared with the third quarter as lower G&A was offset by higher expenses related to distribution and service fees as well as compensation and benefits.
The decrease in G&A was primarily due to lower professional fees and a reduction in virtually hosted conferences.
The increase in distribution and service fee expense, which as noted earlier, excludes the cost of our new closed-end fund, is primarily due to higher average assets under management in U.S. open-end funds.
And the compensation to revenue ratio for the fourth quarter was 35% lower than the guidance we provided on our last call.
The decrease was primarily due to an adjustment to reflect actual incentive compensation to be paid.
For the year, the compensation to revenue ratio was 36.1%.
Our effective tax rate was 25.8% for the fourth quarter, which included an adjustment to bring the full year rate to 26.65%.
The lower full year tax rate was primarily due to the relationship between a consistent amount of permanent differences relative to higher-than-forecasted pre-tax income.
Our firm liquidity totaled $143 million at quarter end compared with $201.9 million last quarter.
Firm liquidity as of December 31 reflected the payment of approximately $60.2 million for costs associated with our new closed-end fund and a special cash dividend in December of approximately $47 million or $1 per share.
Over the past 11 years, we have paid a total of $14 per share in special dividends.
And we remain debt-free.
Assets under management totaled a record $79.9 billion at December 31, an increase of $9.4 billion or 13% from September 30.
The increase was due to net inflows of $3.9 billion and market appreciation of $6.4 billion, partially offset by distributions of $859 million.
Bob Steers will be providing an update on our flows and institutional pipeline of awarded unfunded mandates.
Now I'd like to briefly discuss a few items to consider as we begin the new year.
With respect to compensation and benefits, we expect to balance anticipated revenue growth from year-end assets under management that exceeded our 2020 full year average assets under management by about 15%, with our focus on controlled investment in order to maintain our industry-leading performance, broaden our product offerings and expand our distribution efforts.
As a result, we expect that our compensation to revenue ratio will decline to 35.5% from the 36.1% recorded in 2020.
Continuing with the theme of investing in our business, we expect G&A to increase by about 6% from the $42.6 million we recorded in 2020.
After finishing last year 8% below 2019, which was largely driven by lower travel and entertainment and a reduction in hosted and sponsored conference costs as a result of COVID conditions, we intend to make incremental investments this year in technology, including the implementation of new systems, cloud migration and upgrades to our infrastructure and security as well as in global marketing, focused on hosting virtual conferences and expanding our digital footprint.
We also expect that travel and entertainment costs will increase as conditions begin to return to normal.
We expect that our effective tax rate will be 27.25% in 2021.
And finally, we will have earned a full quarter and full year of fees from our new closed-end fund.
And so all things being equal, we expect our implied effective fee rate, excluding performance fees, will increase by about one basis point.
Today, I will review our investment performance and provide some perspective on how our largest asset classes are positioned for 2021.
The markets were ebullient in the fourth quarter as investors continued to look beyond the valley of the pandemic, encouraged by progress with the vaccine and anticipating a potential economic recovery, relieved by clarity on our new administration and government and supported by record monetary and fiscal stimulus.
The macro environment in 2020 was unprecedented with the Fed's balance sheet increasing by over 75%, the budget deficit reaching the highest level since World War II, money supply growing 25% and negative yielding debt reaching $18 trillion globally.
Although we had some of the best relative performance ever in 2020, our asset classes, except for preferreds, lagged their market counterparts meaningfully.
Summarizing our performance at a high level, preferreds performed competitively within fixed income.
U.S. and Global REITs and infrastructure significantly trailed the technology-led performance in stocks.
And certain of our strategies with energy allocations underperformed due to concerns about the secular decline in the demand for oil, considering the growing focus on renewables.
Looking at our performance scorecard, in the fourth quarter, five of nine core strategies outperformed their benchmarks.
For the last 12 months, six of nine core strategies outperformed.
As measured by AUM, 84% of our portfolios are outperforming on a 1-year basis, an improvement from 70% last quarter, mostly due to our preferred portfolios.
On a 1- and 3-year basis, 99% are outperforming, which was consistent with last quarter.
Preferreds returned 4.6% in the fourth quarter.
We outperformed in both our core and low-duration preferred strategies.
After a brief stretch of underperformance, we've now outperformed for three consecutive quarters.
Our 12-month figures are beginning to turn positive across our accounts, which led to the improvement in our 12-month outperforming AUM.
While our relative performance was mixed in 2020, we outperformed all peers.
Taking stock of the critical factors for preferreds, unprecedented monetary stimulus has helped to compress credit spreads to near record low levels.
Credit quality should benefit as the recovery progresses.
With 2020 elections over, the expectation for more fiscal stimulus, and potentially, with the bottoming of inflation, treasury yields may be transitioning from declining to rising.
As a result, companies are taking their queue from markets and issuing significant amounts of preferreds at a very low cost of capital.
Taken together, these factors lead us to expect lower returns from preferreds, and we are currently suggesting that investors consider our low-duration strategy.
With that as a starting point, we believe that conditions later in 2021 and 2022 may create good entry points for these asset classes as the vaccine continues to be distributed, businesses reopen and recovery brings back the more cyclical real estate and infrastructure subsectors that have been disproportionately hit.
In the fourth quarter, infrastructure returned 8.4%, which lagged the global stock index return of 14.8%.
While we underperformed our benchmark in the fourth quarter, we exceeded our excess return target for the full year.
Assessing the infrastructure universe's sensitivity to the economic situation and pandemic, we believe that 9% benefits from secular trends, 50% is relatively unaffected by the economy and pandemic, 20% is directly sensitive to the economic recovery, and 21% will be reliant on successful penetration of the vaccine.
Key investment themes for infrastructure include digital transformation of economies, including 5G deployment; decarbonization and development of renewable power; and the potential for recovery in travel.
We continue to see adoption of infrastructure allocations with asset consultants and institutions.
With the new administration and potential for additional fiscal stimulus via infrastructure, we also believe that wealth advisors may have more interest as well.
In fact, our closed-end fund, UTF, is now trading at a premium to its NAV, indicating investor demand and anticipation of recovery.
In the fourth quarter, U.S. real estate returned 8.1% compared with the S&P 500, which was up 12.1%, and global real estate returned 13.2%.
For the year, we outperformed our benchmarks in all strategies by region and style and by amounts that exceed our excess return targets across the board.
In terms of where real estate is headed, all eyes are on the vaccine and the timing of the reopening of the economy.
Currently, some sectors such as apartments are seeing stabilization with rents flattening out, which is a key step in the recovery progression.
The secular winners such as cell towers, data centers and industrial continue to have great fundamentals.
Probably, the biggest unknown relates to return-to-office dynamics and the proportion of occupancy that may be permanently impaired.
Broadly speaking, lenders have been kicking the can down the road, but banks are now beginning to feel pressure to address problem loans.
While pricing transparency for many sectors is opaque, we expect transactional activity to pick up as the economic recovery takes hold.
Overall, on most metrics, REITs are very cheap, as cheap as they were in the depths of the global financial crisis in 2009.
As the recovery unfolds, considering how much REITs have lagged, we would expect a catch-up in performance.
I also want to mention that our real assets multi-strategy portfolio had very good relative performance in 2020, outperforming by 200 basis -- 240 basis points for the year, which puts us in good position with investors who are looking for inflation protection.
Looking backward over a period of low inflation, investors had not felt a need for this portfolio, which includes real estate, infrastructure, resource equities, commodities and short-duration credit.
However, it has the highest inflation sensitivity of all of our strategies, and we are seeing increased interest in inflation protection, perhaps no surprise considering the deficit and monetary statistics cited earlier.
As Matt mentioned, allocating resources to our investment department is always a priority.
This past year has been particularly gratifying as we continue to see the growing return on investments we've made over the past five years in our people, IT, processing strategies and data and quantitative resources.
One example is our transition of U.S. REIT team leadership that we announced in the fourth quarter.
Our current head, Tom Bohjalian, will be retiring in the middle of this year, and our succession plan has been put in place with Jason Yablon assuming leadership in partnership with Matt Kirschner.
It's hard to imagine replacing as a strong a leader and investor as Tom.
But in the spirit of continuous improvement, we expect Jason to give Tom a run for his money.
We'll continue to build the team for depth and succession.
We will never be complacent on performance and innovation, and we will continue to drive our Alpha Mining initiatives.
Last quarter, I noted that we have a stable of -- track record accounts for strategies that have been developed over the past three years, ranging from existing strategy extensions to new ideas generated by our investment teams.
All but one outperformed benchmarks last year.
We'll be adding more track record accounts in 2021, including one in renewables and clean energy.
Our challenge will be to convert these investment ideas into investor allocations.
Our recent hire of Greg Bottjer from Nuveen, who heads Global Product Strategy and Development, will help us bring some of these strategies to market as well as map out real asset strategy extensions for the next phase of growth.
Overall, I'd say the state of our investment department is strong.
And we are optimistic about our ability to capitalize on the investment opportunities that are expected to come along with a post-pandemic economic recovery.
Let me start by stating the obvious.
2020 was a year that all of us would like to forget.
The one-two punch of COVID and political and social upheaval has had a devastating impact on our culture and economy, and we're not out of the woods quite yet.
In contrast to the unprecedented challenges that we faced last year, U.S. equity markets posted remarkably positive returns led by the COVID beneficiary plays as demonstrated by the strength in the FAANG and related stocks, as Joe already touched on.
While most active managers continued to battle the dual challenges of declining fees and net outflows, the equity markets offered them a reprieve with the S&P 500 and NASDAQ up 16.3% and 43.6%, respectively, last year.
While alternative income strategies such as preferred securities also performed well, delivering returns in high single digits, most real asset strategies, notably real estate and infrastructure, did not.
As Joe noted, global and U.S. real estate securities indices actually declined by 9% and 5.1%, respectively, while global listed infrastructure indices also fell by 4.1%.
It's a point of pride for us that unlike our peers in the industry that benefited from market appreciation, we faced significant market headwinds last year, and yet, still generated industry-leading organic growth.
Importantly, our growth was broad-based and -- with almost every region, strategy and channel contributing to record-breaking results.
We ended the quarter with record assets, as Matt said, of $79.9 billion.
Assets under management in each of the open-end fund, closed-end fund and advisory channels also ended the year at record levels.
In the quarter, gross inflows were a record $7.3 billion and net inflows contributed $3.9 billion.
Virtually, all the organic growth in the quarter was derived from the wealth channel.
Our confidence in the new generation of closed-end funds paid off in the quarter, and we added $2.1 billion of net new assets through the IPO of our Tax-Advantaged Preferred Securities and Income Fund.
Although not a record, our open-end fund channel registered $1.7 billion of net inflows, driven mainly by preferred securities and U.S. real estate strategies.
Notably, each of the RIA, BD, DCIO and Bank Trust verticals generated positive net inflows in the quarter.
Our non-U.S. open-end fund showed modest improvement, albeit from low levels, with net inflows of $41 million in the quarter.
We are continuing to build out our EMEA wholesale distribution team and fully expect that these nascent positive trends will improve.
Consistent with more recent trends, Japan subadvisory saw net inflows of $83 million before distributions and $293 million of net outflows after distributions.
And it was a quiet quarter for subadvisory ex Japan with $10 million of net inflows.
While the headline results for the advisory channel of $101 million of net outflows was disappointing, the underlying trends continue to be strong.
five new mandates totaling $297 million, combined with $282 million of inflows from existing clients, contributed $579 million of gross inflows.
Offsetting these inflows was an unexpected $301 million global real estate outflow, stemming from the termination of a relatively new institutional account, along with a global listed infrastructure termination totaling $299 million.
We do expect the balance of the terminated global real estate account of approximately $960 million to be withdrawn in the next quarter or 2.
Lastly, the quarter ended with a record-setting pipeline of $1 billion, but unfunded mandates of $1.7 billion.
The quarter began with a $1.2 billion pipeline.
$400 million was funded in the quarter, and another $280 million has been deferred due to funding uncertainties.
New awards totaled $1.1 billion.
These new awards were diverse both by strategy and region.
Demand for our strategies, especially real assets remained strong, driven by relative performance, attractive valuations and rising concerns regarding future inflation expectations.
As you know, in recent years, our overarching goal has been to achieve positive flows in each of our core strategies and in every channel and region simultaneously.
To accomplish these results, we have invested continuously in our investment teams, IT, existing and new channels of distribution, innovative new investment strategies, and most importantly, in our people and culture.
So while 2020 was a terrible year in so many ways, it was also a year to be proud of at Cohen & Steers.
All of our teams came together under crisis conditions to deliver a cascade of record results.
For the full year, firmwide gross sales were $27.4 billion, which exceeded the prior record achieved in 2011 of $17 billion by 61%.
Open-end fund gross sales of $17.6 billion were 41% above the prior record, and closed-end fund sales of $2.7 billion similarly blew by the prior record by more than double.
Even in the transition year for us in the U.S. institutional market, our advisory channel recorded sales of $4.3 billion, which was more than 100% better than the prior -- the record set in 2018.
Net inflows last year also set a record at $10.8 billion.
While this was only modestly above the prior record set in 2011, it highlights the important progress that we've made in diversifying our sources of organic growth.
In 2011, net inflows were $10.7 billion.
However, subadvisory inflows from Daiwa Asset Management contributed 81% of that amount in one single strategy.
In contrast, last year, six strategies across open-end funds, closed-end funds and advisory contributed $5.4 billion, $2.6 billion and $1.6 billion of net inflows, respectively, and each setting individual channel records and accounting for almost 90% of firmwide totals.
Achieving these results despite significant market declines for most of our strategies is extraordinary and bodes well for the future.
Strong investment performance in our core strategies has helped us to gain significant market share from our active peers and even passive alternatives.
Seeding and launching innovative new strategies, such as low duration and tax-advantaged preferred securities, next-generation real estate and digital infrastructure has been well received, and our product pipeline is robust.
In addition, expanding and improving the delivery of our strategies through the launch of usage funds, CITs, SMAs and closed-end funds has materially broadened our distribution reach and opportunities.
Lastly, our focus on improving underperforming distribution channels such as U.S. Advisory is starting to pay dividends.
Maintaining the current level of organic growth will not only require a continuation of industry-leading investment performance but also the development of the next generation of innovative real asset and alternative income strategies to complement our existing lineup.
We believe that in the current market cycle, a significant shift in asset allocations into real assets, seeking to capitalize on depressed valuations and the potential to hedge against unexpected inflation is taking place.
Current and prospective clients are looking to us to implement their strategies through both listed and private markets.
In response to our clients' needs and to maintain our leadership position in real assets and alternative income strategies, we plan to expand our opportunity set and related capabilities to include non-traded equity and fixed income investments.
In addition, an important point of differentiation for us will be the ability to deliver all of our capabilities through strategically allocated and bespoke solutions.
As always, we're committed to invest as necessary to drive our long-term growth.
With that, I'd like to ask the operator to open up the floor to questions.
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cohen & steers inc - diluted eps, as adjusted, of $0.76 for the fourth quarter.
cohen & steers inc - net inflows of $3.9 billion for the fourth quarter.
cohen & steers inc - quarter end aum of $79.9 billion.
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We have in the room today, Nick DeIuliis, our President and Chief Executive Officer; Don Rush, our Chief Financial Officer; Chad Griffith, our Chief Operating Officer; and Yemi Akinkugbe, our Chief Excellence Officer.
Today, we will be discussing our first quarter results.
And then we will open the call up for Q&A.
Then we're going to go over to Don Rush, our Chief Financial Officer, to talk about the financials, and then Yemi will wrap things up to talk about some thoughts on ESG that we've got.
But starting now on Slide two.
There's one main theme that I think is important to highlight, and the theme there is steady execution.
First quarter was another example of steady execution, and it's illustrated by us generating $101 million in free cash flow.
This is the fifth consecutive quarter that the company generated significant free cash flow.
Similar to last quarter, we used some of that free cash flow to pay down debt.
That helped build further liquidity.
And we use some of the free cash flow to buy back our shares in the open market at attractive pricing.
So for the quarter, we repurchased 1.5 million shares at an average price of $12.26 per share at a total cost of $18 million.
We still have ample capacity of around $240 million under our existing stock repurchase program, which, as a reminder, that's not subject to an expiration date.
Also in the quarter, we upped our free cash flow guidance by $25 million to $450 million.
That's $2.04 per share compared to the previous guidance of $1.93 per share.
Our steady performance drives our confidence in continuing to execute upon our seven year free cash flow plan, and we continue to expect will generate over $3 billion over those seven years.
Again, this is done by steady execution each and every day.
Our long-term plan is largely derisked through our hedging program that supports us a simple operational program that consists of one rig and one frac group.
We've worked hard to get the company to where we are today, and our focus is going to remain on successfully executing that plan.
I want to jump over now to Slide three.
This is a slide that we have shown for the past few quarters now, but I think that it's a really powerful one.
Our competition for investor capital is not so much among just our Appalachian peers, but more so across the broader market.
And as you can see by three of the main financial metrics that we track, CNX streams incredibly well across various metrics and indices.
We believe that these things matter most to generalist investors, along with what has become a much simpler differentiated story.
CNX is a differentiated company due to the structural cost advantage we enjoy compared to our peers, mainly because we own our midstream infrastructure.
And this moat provides us with superior margins that drive significant free cash flow, which, in turn, puts us in a unique position to flexibly allocate capital across the full spectrum of shareholder value creation opportunities.
While our near-term focus is to continue to reduce debt and opportunistically acquire shares, we continually evaluate all our alternatives that we've got.
So last, in that regard, with respect to the often asked about potential M&A activity, our view remains consistent from last time we spoke.
Our two key screening metrics or the ability to deliver long-term free cash flow per share accretion and having good risk-adjusted returns.
The strength of our company affords us the ability to be patient on this front to ensure that we avoid M&A missteps that too often permanently can destroy shareholder value.
With that, now, I'm going to turn things over to Chad.
I'm going to start on Slide four, which highlights some of the key metrics that make CNX an incredibly attractive investment today, particularly relative to our peers.
For us, it begins in the upper right quadrant where we illustrate our peer-leading production cash costs.
While our Q1 result of $0.66 is up roughly $0.05 quarter-over-quarter, we're still more than $0.11 better than our next closest competitor.
It's also worth noting that, that $0.05 increase was driven predominantly by some reworking of our FT book, which allowed us to eliminate some unused FT and exchanges for some FT that is better matched up with our production locations.
As Don will go into more details momentarily, our low production cash costs allow us to generate more operating cash flow per Mcfe at a given gas price relative to our peers.
And this operating margin creates -- this operating margin advantage creates many other advantages for CNX.
First, we'll generate more EBITDA per Mcfe, which means we need less daily production to achieve the same level of EBITDA compared to our peers.
This allows us to maintain that level of EBITDA, but less maintenance drilling, thereby consuming fewer of our acres each year.
The operating margin advantage also enhances each well's return on capital, which means a greater subset of our net acres are in the money.
So fewer well each year from a broader amount of net acres means that we'll be able to sustain this formula for decades to come.
By the way, the lower number of new wells required to maintain our EBITDA means that less of that EBITDA is consumed by maintenance capital expenditures.
That is how we generate, on average, $500 million per year of free cash flow over the next six years at strip pricing.
Wrapping up this slide, you can see that we continue to trade at very attractive free cash flow yield on our equity, while continuing to pay down debt and returning capital to shareholders.
Slide five is another illustration of our cost structure when you look at it on a fully burdened basis.
That means that this cost illustration includes every cash cost that exists in our business.
We expect cost to continue to improve, primarily driven by a reduction in the other expense bucket, which consists primarily of interest coming down and additional unused FT rolling off.
We are expecting around $10 million of unused firm transportation to roll off in 2021, a modest amount next year in 2022 and then another $20 million rolling off across -- through 2023 through 2025.
These are simply contractual agreements that are expiring.
So with these changes, and assuming all future free cash flow goes toward debt repayments, we would expect fully burden cost to decrease to around $0.90 per Mcfe and then lower in years beyond 2021.
Before handing it over to Don, I wanted to spend a couple of minutes on our operations, the gas markets and provide a hedge book update.
During the quarter, we turned in line five Marcellus wells, and we're in the process of drilling out another 13 that will be turned in line within the next two weeks.
Those 18 wells had an average lateral length of just over 13,000 feet and has an average all-in cost of less than $650 per foot per lateral foot.
Also during the quarter, we brought online two Southwest PA Utica wells, the Majorsville 12 wells.
Deep Utica have continued to come down with the all-in capital cost for these two wells averaging $1,420 per lateral foot.
Production from these wells are being managed as part of our blending program, but we're very encouraged by the data we're seeing.
As we've really discussed, we only have four additional SWPA Utica wells in our long-term plan through 2026, but based on what we're seeing so far at Majorsville 12, we're excited about the deep Utica's potential as either a growth driver if gas prices improve or as a continuation of our business plan for years and into the future.
As for our CPA Utica region, as a reminder, we continue to expect about a pad a year through the end of the 2026 plan.
This continues to be an area that we are very excited about.
Shifting to the gas markets, we saw weakening in the near-term NYMEX and weakening to the curve of in-basin markets.
As a gas producer, we're always rooting for stronger prices.
But fortunately, our cost structure and hedge book make higher prices a luxury for CNX, instead of a necessity as it is for many of our peers.
The way we see it, there are four fundamental drivers of gas price that need to be in our favor to actually see higher gas prices.
One, moderate production levels; two, lower storage levels; three, higher weather-related demand; and four, sustained levels of LNG exports.
If all four hit, expect gas prices to surge.
But despite our optimism and others' dire needs, it's becoming less likely each year that all four of those factors line up in favor of strong gas prices.
As an example, just last year, everyone was expecting all four factors to line up in 2021, and the forward curve surge, but a mild winter, lack of strong winter storage draw and growing drilling and completion activity have weighed on 2021 pricing.
The difficulty in having all four factors line up in favor of strong gas prices is why we will continue to focus on being the low-cost producer and protecting our revenue line through our programmatic hedging program.
That's why we do not rely on full commodity cases to make projections or investment decisions.
Insead, our free cash flow projections and investment decisions are based on the forward stroke.
Speaking of our hedging program, during Q1, we added 136 Bcf of NYMEX hedges, 15.5 Bcf of index hedges and 61.3 Bcf of basis hedges.
For 2021, we are now approximately 94% hedged on gas based on the midpoint of our guidance range and after backing out 6% to liquids.
That 94% includes both NYMEX and basis hedges or fully covered volumes, which are hedged at $2.48 per Mcf.
It is a true realized price that we will receive in the year.
We are also now fully hedged on in-basin basis through 2024.
We will continue to programmatically hedge our volumes before we spend capital by locking in significant economics, which are supported by our best-in-class cost advantage.
Q1 was the fifth consecutive quarter of generating significant free cash flow and consistent execution of our plan.
Our confidence in future execution supports a $25 million increase in our 2021 free cash flow guidance and our continued expectation to generate over $3 billion across our long-term plan.
Slide seven is a new slide that highlights our superior conversion of production volumes into free cash flow.
The top chart highlights that CNX is able to convert production volumes into EBITDA more efficiently than our peers as a result of our low-cost structure generating higher margins.
The bottom chart further highlights the superior conversion cycle through a reinvestment rate metric, which is simply capital divided by operating cash flow.
As you can see, CNX has an incredibly low reinvestment rate, which supports our expectation to generate average annual free cash flow of $500 million across our long-term plan.
Our profitability profile allows us to generate an outsized free cash flow per Mcfe of gas and per dollar of capital spending.
Also, this low reinvestment rate demonstrates the company's commitment to generating cash used toward investor-friendly purposes, which include balance sheet enhancement and returning capital to shareholders.
Slide eight highlights our balance sheet strength.
We have no bond maturities due until 2026, so we have a substantial runway ahead of us that provides significant flexibility.
In the quarter, we reduced net debt by approximately $70 million.
And after the close of the quarter, we completed our semiannual bank redetermination process to reaffirm our existing borrowing base.
Lastly, as you can see on the slide, our public debt continues to trade in the 4% to 5% range.
Now let's touch on guidance that is highlighted on Slide nine.
There are a couple of updates on this slide.
The first is the pricing update, which is simply a mark-to-market on what NYMEX and Basis are doing for cal 2021 as of April seven compared to our last update, which was as of January 7, 2021.
We also increased our NGL realization expectations by $5 per barrel as a result of the increase in expected NGL realizations.
As we have already highlighted, we are increasing free cash flow for the year by $25 million.
Lastly, there are a few other guidance related items to highlight that are not captured on this slide that I would like to address in advance of questions.
We expect production volumes to be generally consistent each quarter throughout the rest of the year, with a very slight decrease expected in the second quarter.
As for capital cadence, we expect capital to have a bit more variation.
Specifically, we expect our first half capital to be more than our second half capital, so Q2 should be near Q1 and Q3 and Q4 a bit less.
As we have said previously, quarterly capex cutoffs are difficult to predict since a pad going a bit faster or a bit slower can change the period numbers materially without changing our long-term plan and forecast at all.
I'm Yemi Akinkugbe, the Chief Excellence Officer here at CNX.
A few of you may be wondering what exactly this role entail.
The short answer is I oversee and manage all operational and corporate support function withing the company.
The longer answer is what I want to speak about in more detail today.
We've been focused on the underlying tenets of ESG and its benefit with generation.
This is an effect or a means we only talk about to ponder up to certain interest for short-term end.
Instead, the concept was part of our fabric long before the current management team joined the company, and it will be part of our fabric long after it's gone.
With that backdrop, let's talk for a minute where we have been and where we are heading on this front.
A lot of you when it comes to ESG is simple and can really be summed up in three words: tangible; impactful; local.
We've been the first mover across the board, and I just want to highlight a few of our significant accomplishments over the years.
First, we proactively reduced Scope one and two CO2 emissions over 90% since 2011, something that a few, if any, of any public company had claimed.
Two, we were the early adopters and innovators of commercial-scaled coalbed methane capture in the 1980s.
This resulted in historical mitigation of cumulatively over 700 Bcf of methane emission that would have otherwise been vented into the atmosphere.
Annually, we capture nearly as much methane from this operation than the nation's largest waste management company does from its landfill.
That ingenuity and leadership on a key tenet of ESG is what ultimately birth this company we see today.
Three, we were the first to fully deploy an all-electric frac spread in the Appalachian Basin.
This improved our emission footprint, increased our efficiency and support our best-in-class operational cost performance.
The elimination of diesel fuel in this operation is equivalent to taking 23,000 passenger vehicles off the road for a year.
We recycled 98% of produced fluid in our core operation.
This prevented unnecessary water withdrawal and eliminates the need for disposal.
Our unique pipeline network decreases the need for water trucking, which have the dual benefit of reducing community impact of trucking, while reducing overall air quality emissions.
These achievements are important and impactful, but ESG is not just about proven track record.
To us, it's about what we are doing now and how we'll continue to push the envelope through intangible, impactful and local accomplishments.
Committing to target or goals decades into the future without a concrete path to accomplish them and without accountability for those words, in our opinion, is the epitome of flawed corporate governance.
These are the strategies that have allowed CNX to thrive for over 150 years and will continue to drive our success.
Let me introduce a few of our efforts this year.
We introduced methane-related KPIs into our executive compensation program.
We've committed to make substantial multi-year community investment of $30 million over the next six years to widen the path of the middle class in our local community, while growing the local talent pipeline.
We've redoubled our efforts to spend local and hire locally.
100% of our new hires will be from our area of operation, and we will maintain at least 90% local contract workforce.
We committed 6% of our contract spend to local, diverse and businesses in 2021 and dedicated 40% of the total CNX small business spend to companies within the Tri-State area.
We adopted a task force on climate-related financial disclosure, or TCFD framework and a FASB standard for both our E&P and midstream operation.
In addition, the transparency and the financial sustainability of our business is second to none.
One year into our seven year free cash flow generation plan, we have a low-risk balance sheet driven by the most efficient, lowest cost operation in the basin.
This leads to independence from equity and debt market when pursuing value creation.
Finally, while you will hear more about this in the weeks and months ahead, I want to take the opportunity to announce that CNX is developing an innovative proprietary solution in combination with a few commercial solutions that allows us to significantly minimize from a blowdown and pneumatic devices, which make up about 50% of our emission source.
The blowdown solution under development will also allow us to recirculate methane, which will otherwise be admitted into the atmosphere back into the gathering system.
This is yet another leadership step for a company that continues to lead and deliver tangible impactful ESG performance that is reducing risk and creating sustainable value for our shareholders.
Tangible, impactful, local ESG is our brand of ESG.
We don't follow the herd.
We chart our own course and do what we know is right and impactful over the long term for employees, our communities and our shareholders.
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qtrly average daily production 1,562.5 mmcfe versus 1,476.5 mmcfe.
2021e fcf guidance increased to approximately $450 million.
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To access the call on the Internet, please log on to Capital One's website at capitalone.com and follow the links from there.
In the second quarter, Capital One earned $3.5 billion or $7.62 per diluted common share.
Included in the results for the quarter was a $55 million legal reserve build.
Net of this adjusting item, earnings per share in the quarter was $7.71.
On a GAAP basis, pre-provision earnings increased slightly in the sequential quarter to $3.4 billion.
We recorded a provision benefit of $1.2 billion in the quarter as $541 million of charge-offs was offset by a $1.7 billion allowance release.
Revenue grew 4% in the linked quarter, largely driven by the impact of strong Domestic Card purchase volume on noninterest income and the absence of the mark on our Snowflake investment a quarter ago.
Period-end loans held for investment grew $6.5 billion or 3%, inclusive of the effect of moving $4.1 billion of loans to held-for-sale during the quarter.
The loans moved to held-for-sale consisted of $2.6 billion of an International Card partnership portfolio and $1.5 billion in commercial loans.
Turning to Slide 4.
I will cover the changes in our allowance in the quarter.
We released $1.7 billion of allowance, primarily driven by observed strong credit performance and an improved economic outlook.
Turning to Slide 5.
We provide the allowance coverage ratios by segment.
You can see allowance coverage declined in the quarter across all segments, largely reflecting the dynamics I just described.
However, coverage ratios remain well above pre-pandemic levels due to continued economic uncertainty as our allowance is built to absorb a wide range of outcomes.
Our Domestic Card coverage is now 8.9%, down from 10.5% last quarter.
Our branded card coverage is 10.1%.
Recall that the difference between branded and domestic coverage is largely driven by the loss sharing agreements in some of our partnership portfolios.
Coverage in our consumer business declined about 60 basis points to 3%.
In addition to continued strong credit performance and improved economic outlook, historically high auto values aided the reduction in coverage.
Coverage in our Commercial Banking business declined about 25 basis points to 1.7%, with the single largest driver being the improvement in our energy portfolio.
Turning to Page 6.
I'll now discuss liquidity.
You can see our preliminary average liquidity coverage ratio during the first -- during the quarter was 141%.
The LCR continues to be well above the 100% regulatory requirement.
Our liquidity reserves from cash, securities and Federal Home Loan Bank capacity ended the quarter at approximately $137 billion.
The $14 billion decline in total liquidity was driven by lower ending cash balances.
Our cash position declined in the quarter as it was redeployed to net loan growth, wholesale funding maturities, a modest increase in our securities portfolio and share repurchases.
Moving to Page 7.
I'll now discuss net interest margin.
You can see that our second quarter net interest margin was 5.89%, 10 basis points lower than the prior quarter.
The linked-quarter decline in NIM was largely driven by lower yield in our card portfolio, where the typical seasonal decrease in revolve rate was exacerbated by higher transactor volume and associated higher payments.
These impacts were partially offset by the favorable impact from one more day in the quarter.
Lastly, turning to Slide 8.
I will cover our capital position.
Our common equity Tier 1 capital ratio was 14.5% at the end of the second quarter, down 10 basis points from the first quarter.
Loan growth and capital actions were largely offset by earnings growth.
During the quarter, the Federal Reserve released the results of their stress test.
Our stress capital buffer requirement, which will be effective on October 1 of this year, is 2.5%, resulting in a total capital requirement by the Fed of 7%.
While we saw a decline in this year's SCB, it's important to note that the Fed's stress testing results can move around meaningfully from year to year and are only one of many factors that we use in our capital planning process.
Based on our internal modeling, we continue to estimate that our CET1 capital need is around 11%.
Turning to share repurchases.
We repurchased $1.7 billion of common stock in the second quarter, the full amount allowed under the Fed's capital preservation measures.
We have approximately $5.3 billion remaining of our current board authorization of $7.5 billion.
Now let me move on to dividends.
In the third quarter of 2020, we reduced our dividend to $0.10 due to the Fed's capital preservation measures.
We chose to continue this reduced level of dividend in the fourth quarter of 2020 out of an abundance of caution.
The difference between our historical $0.40 dividend and the reduced level for those two quarters was $0.60 per common share.
Therefore, we expect to make up for the reduced level of dividends from the second half of 2020 by paying a $0.60 special dividend in the third quarter of 2021.
In addition to the special dividend, we expect to increase our quarterly common stock dividend from $0.40 per share to $0.60 per share in the third quarter.
Both the $0.60 special dividend and the increase of our quarterly common stock dividend to $0.60 will be subject to board approval.
I'll begin on Slide 10 with our Credit Card business.
Strong year-over-year purchase volume growth drove an increase in revenue compared to the second quarter of 2020, more than offsetting a modest year-over-year decline in loan balances.
And provision for credit losses improved significantly.
Credit Card segment results are largely a function of our Domestic Card results and trends, which are shown on Slide 11.
Second-quarter results reflect building momentum in our Domestic Card business.
As we emerge from the pandemic, consumers are spending more and continuing to make elevated payments.
Accelerating purchase volume growth partially offset the impact of historically high payment rates, resulting in strong revenue growth and a more modest year-over-year decline in loan balances.
High payment rates are continuing to contribute to strikingly strong credit results.
Domestic Card purchase volume for the second quarter was up 48% from the second quarter of 2020.
Purchase volume was up 25% from the second quarter of 2019, which is an acceleration from the first quarter when we saw growth of 17% versus 2019.
T&E spending continues to catch up to overall spending and accelerated through the second quarter.
In June, T&E purchase volume was up 3% compared to June of 2019.
At the end of the quarter, Domestic Card loan balances were down $4.1 billion or about 4% year over year.
Excluding the impact of a partnership portfolio moved to held-for-sale last year, second quarter ending loans declined about 2% year over year.
Compared to the sequential quarter, ending loans were up about 5%, ahead of typical seasonal growth of 2%.
Credit performance remained strikingly strong.
The Domestic Card charge-off rate for the quarter was 2.28%, a 225-basis-point improvement year over year.
The 30-plus delinquency rate at quarter end was 1.68%, 106 basis points better than the prior year.
Provision for credit losses improved by about $3.5 billion year over year.
We swung from a large allowance build in the second quarter last year to a large allowance release this year.
Let me turn to Domestic Card revenue margin.
Purchase volume growth outpacing loan growth and strong credit were the key drivers of Domestic Card revenue margin, which was up 226 basis points year over year to 17.7%.
Revenue margin increased over 50 basis points quarter over quarter, higher than our typical seasonal pattern.
Total company marketing expense was $620 million in the quarter, up $347 million compared to the second quarter of 2020.
Our choices in card marketing are the biggest driver of total company marketing trends.
As we emerge from the pandemic, we're seeing strong originations and purchase volumes.
Our growth opportunities are enhanced by our technology transformation.
We are leaning further into marketing to drive future growth and continue to build our franchise.
At the same time, we're keeping a watchful eye on the competitive environment, which is intensifying.
Pulling up, our Domestic Card business continues to deliver significant value and build momentum.
Slide 12 summarizes second quarter results for our Consumer Banking business.
Auto growth and exceptional auto credit are the main themes in second quarter Consumer Banking results.
Driven by auto, second quarter ending loans increased 12% year over year in the Consumer Banking business.
Average loans also grew 12%.
Auto originations were up 56% year over year and up 47% from the linked quarter.
Pent-up demand and high auto prices drove a second quarter surge in growth across the auto marketplace.
In the context of increased industry growth, our digital capabilities and deep dealer relationship strategy continued to drive strong growth in our auto business.
Second quarter ending deposits in the consumer bank were up $4.4 billion or 2% year over year.
Average deposits were up 9% year over year.
Consumer Banking revenue increased 27% from the prior-year quarter, driven by growth in auto loans and retail deposits.
Second-quarter provision for credit losses improved by $1.2 billion year over year, driven by an allowance release and lower charge-offs in our auto business.
Credit results in our auto business are strikingly strong.
Year over year, the second quarter charge-off rate improved 120 basis points to negative 0.12%, and the delinquency rate was essentially flat at 3.26%.
In the quarter, elevated used car prices drove an increase in auction proceeds, amplifying the normal seasonal benefit we see from tax refunds around this time of the year.
As used vehicle prices normalize, they will become a headwind to the auto charge-off rate.
we expect the auto charge-off rate to increase from the unusually low second quarter level.
Moving to Slide 13.
I'll discuss our Commercial Banking business.
Second quarter ending loan balances were down 5% year over year.
Average loans were down 7%.
Commercial line utilization continues to be down year over year, and we moved $1.5 billion of commercial real estate loans to held-for-sale.
Quarterly average deposits increased 22% from the second quarter of 2020 and 5% from the linked quarter as middle market and government customers continue to hold elevated levels of liquidity.
Second-quarter revenue was up 3% from the prior-year quarter and down 6% from the linked quarter.
The linked quarter decline is more than entirely driven by a one-time cost associated with moving the commercial real estate loans to held for sale.
This decline was offset by an equivalent one-time gain in the other category and is therefore neutral to the company.
Excluding this effect, Commercial Banking revenue would have increased about 13% year over year and 4% from the linked quarter.
Provision for credit losses improved significantly compared to the second quarter of 2020, driven by a swing from an allowance build to an allowance release and a swing from net charge-offs to net recoveries.
In the second quarter, the Commercial Banking annualized charge-off rate was negative 11 basis points.
The criticized performing loan rate was 7.6%, and the criticized nonperforming loan rate was 1%.
Our Commercial Banking business is delivering solid performance as we continue to build our commercial capabilities.
I'll close tonight with some thoughts on our results and our strategic positioning.
Several key themes are evident in our second quarter results.
Credit remains strikingly strong.
Purchase volume and loans are rebounding.
We're continuing to invest to propel our future results, and we're returning capital to our shareholders.
We are seeing increasing near-term opportunities to build our Domestic Card business as we emerge from the pandemic.
We are leaning further into marketing to seize these opportunities.
We are also increasing our marketing for auto, national banking and our brand.
We are now in the ninth year of a journey to build a modern technology company from the bottom of the tech stack up.
Our progress is accelerating, and the stakes are rising.
Competitor tech investments are increasing as technology is increasingly seen as an existential issue.
The investment flowing into fintechs is nothing short of breathtaking.
And the war for tech talent continues to escalate, including levels of compensation.
We continue to invest in technology and the opportunities that emerge as our transformation gains traction.
Our modern technology is powering our current performance and setting us up to capitalize on the accelerating digital revolution in banking.
We'll now start the Q&A session.
[Operator instructions] If you have follow-up questions after the Q&A session, the Investor Relations team will be available after the call.
Holly, please start the Q&A.
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compname reports second quarter 2021 net income of $3.5 billion, or $7.62 per share.
q2 adjusted earnings per share $7.71 excluding items.
qtrly provision (benefit) for credit losses decreased $337 million to $(1.2) billion versus q1 2021.
qtrly net interest margin of 5.89%, a decrease of 10 basis points versus q1 2021.
qtrly earnings per share $7.62.
common equity tier 1 capital ratio under basel iii standardized approach of 14.5% at june 30, 2021.
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To access the call on the internet, please log on to Capital One's website at capitalone.com and follow the links from there.
With me this evening are Mr. Richard Fairbank, Capital One's chairman and chief executive officer; and Mr. Andrew Young, Capital One's chief financial officer.
In the fourth quarter, Capital One earned 2.4 billion or $5.41 per diluted common share.
For the full year, Capital One earned 12.4 billion or $26.94 per share.
On an adjusted basis, full year earnings per share were $27.11.
Full year ROTCE was 28.4%.
Included in the results for the fourth quarter was an upgrade to a legacy rewards program, which increased our rewards liability and decreased noninterest income by $92 million.
Both period end and average loans held for investment grew 6% on a linked-quarter basis.
Ending loans grew 10% in domestic card, 7% in commercial, and 1% in consumer banking.
Revenue in the linked quarter increased 4%, driven by the loan growth I just described, while total noninterest expense increased 12% in the quarter, driven by increases in both operating and marketing expenses.
Provision expense in the quarter was 381 million and net charge offs of 527 million were partially offset by a modest allowance release.
Turning to Slide 4, I will cover the changes in our allowance in greater detail.
For the total company, we released 145 million of allowance in the fourth quarter, bringing the total allowance balance to 11.4 billion.
The total company coverage ratio now stands at 4.12%.
Turning to Slide 5, I'll discuss the allowance of each of our segments in greater detail.
As you can see in the graphs, our allowance coverage ratio declined in each of our segments.
In domestic card, the allowance balance remained flat at $8 billion.
The decline in card coverage was driven by the impact of balanced growth that I highlighted earlier.
In our consumer banking segment, continued strength in auto auction values drove a decline in both the allowance balance and the coverage ratio.
And in commercial, the decline in allowance balance was driven by modest credit improvement in the existing portfolio.
In addition to the allowance decline, the coverage ratio was also aided by growth in lower loss segments.
Turning to Page 6, I'll now discuss liquidity.
You can see, our preliminary average liquidity coverage ratio during the fourth quarter was 139%.
The LCR remains stable and continues to be well above the 100% regulatory requirement.
We continue to gradually run off excess liquidity built during the pandemic.
Relative to the prior quarter, ending cash and equivalents were down about $5 billion.
And investment securities were down about $3 billion as we used our liquidity to fund loan growth and share buybacks.
Turning to Page 7, I'll cover our net interest margin.
You can see that our fourth quarter net interest margin was 6.6%, 25 basis points higher than Q3 and 55 basis points higher than the year-ago quarter.
The linked-quarter increase in NIM was largely driven by balance sheet mix as we had a reduction in cash and securities, as well as a higher amount of card loans.
Outside of quarterly day count effects, the NIM from here will largely be a function of the change in card balances, cash and securities levels, and interest rates.
Turning to Slide 8, I will end by discussing our capital position.
Our common equity Tier 1 capital ratio was 13.1% at the end of the fourth quarter, down 70 basis points from the prior quarter.
Net income in the quarter was more than offset by share repurchases and growth in risk-weighted assets.
We continue to estimate that our CET1 capital need is around 11%.
In the fourth quarter, we repurchased $2.6 billion of common stock, which completed our $7.5 billion board authorization.
Our board of directors has approved an additional repurchase authorization of up to $5 billion of the company's common stock.
I'll begin on Slide 10 with our credit card business.
Accelerating year-over-year growth in purchase volume and loans, coupled with strong revenue margin, drove an increase in revenue compared to the fourth quarter of 2020.
Credit card segment results are largely a function of our domestic card results and trends, which are shown on Slide 11.
As you can see on Slide 11, our domestic card business posted strong growth in every top-line metric in the fourth quarter.
Purchase volume for the fourth quarter was up 29% year over year and up 30% compared to the fourth quarter of 2019.
The rebound in loan growth accelerated, with ending loan balances up $10.2 billion or about 10% year over year.
Ending loans also grew 10% from the sequential quarter, ahead of typical seasonal growth of around 4%.
Ending loan growth was the result of the strong growth in purchase volume, as well as the traction we're getting with new account origination and line increases, partially offset by continued high payment rates.
And revenue was up 15% year over year, driven by the growth in purchase volume and loans.
Domestic card revenue margin increased 123 basis points year over year to 18.1%.
Two factors drove most of the increase: revenue margin benefited from spend velocity, which is purchase volume and net interchange growth outpacing loan growth; and favorable year-over-year credit performance enabled us to recognize a higher proportion of finance charges and fees in fourth quarter revenue.
Credit results remain strikingly strong.
The domestic car charge-off rate for the quarter was 1.49%, a 120-basis-point improvement year over year.
The 30-plus delinquency rate at quarter-end was 2.22%, 20 basis points better than the prior year.
On a linked-quarter basis, the charge-off rate was up 13 basis points and the delinquency rate was up 29 basis points.
Noninterest expense was up 24% from the fourth quarter of 2020.
The biggest driver of noninterest expense was an increase in marketing.
Total company marketing expense was $999 million in the quarter.
Our choices in domestic card marketing are the biggest driver of total company marketing trends.
We continue to see attractive opportunities to grow our domestic card business, and our growth opportunities are enhanced by our technology transformation.
We continue to lean into marketing to drive growth and build our domestic card franchise.
At the same time, we're keeping a watchful eye on the competitive environment, which is intensifying.
Pulling up, our domestic card business continues to deliver significant value as we invest to grow and build our franchise.
Moving to Slide 12, strong loan growth in our consumer banking business continued in the fourth quarter.
Driven by auto, fourth quarter ending loans increased 13% year over year in the consumer banking business.
Average loans also grew 13%.
Fourth quarter auto originations were up 32% year over year.
Our digital capabilities and deep dealer relationship strategy continued to drive year-over-year growth in our auto business.
In the fourth quarter, we saw a pickup in competitive intensity in the marketplace.
On a linked-quarter basis, auto originations were down 16%.
Fourth quarter ending deposits in the consumer bank were up $6.6 billion or 3% year over year.
Average deposits were up 2% year over year.
Consumer banking revenue grew 7% from the prior-year quarter, driven by growth in auto loans, partially offset by declining auto loan yields.
Noninterest expense increased 15% year over year.
Fourth quarter provision for credit losses improved by $58 million year over year, driven by an allowance release in our auto business.
The auto charge-off rate and delinquency rate remains strong and well below pre-pandemic levels.
On a linked-quarter basis, the charge-off rate for the fourth quarter was 0.58%, up 40 basis points; and the 30-plus delinquency rate was 4.32%, up 67 basis points.
Slide 13 shows fourth quarter results for our commercial banking business, which delivered strong growth in loans, deposits, and revenue in the quarter.
Fourth quarter ending loan balances were up 12% year over year, driven by growth in selected industry specialties.
Average loans were up 8%.
Ending deposits grew 13% from the fourth quarter of 2020 as middle market and government customers continued to hold elevated levels of liquidity.
Quarterly average deposits also increased 14% year over year.
Fourth quarter revenue was up 19% from the prior-year quarter, with 29% growth in noninterest income.
Noninterest expense was up 17%.
Commercial credit performance remained strong.
In the fourth quarter, the commercial banking annualized charge-off rate was a negative 2 basis points.
The criticized performing loan rate was 6.1%, and the criticized nonperforming loan rate was 0.8%.
Our commercial banking business is delivering solid performance as we continue to build our commercial capabilities.
I'll close tonight with some thoughts on our results and our strategic positioning.
Growth momentum is evident throughout our fourth quarter results.
In the quarter, we drove strong growth in domestic card revenue, purchase volume, and loans.
We also posted strong auto and commercial growth.
Credit remains strikingly strong across our businesses, and we continue to return capital to our shareholders.
As we enter 2022, we continue to see attractive opportunities to grow our businesses and build our franchise.
We will continue to lean into marketing to capitalize on these opportunities and drive growth.
For years, we've talked about how sweeping digital change and modern technology are changing the game in banking.
Last quarter, I noted that the stakes are rising faster than ever before.
The investment flowing into fintech is breathtaking, and it's growing.
Also, many legacy companies are embracing the realization that technology capabilities may be an existential issue for them and are increasing technology investments.
The war for tech talent continues to escalate, which is driving up tech labor costs even before any headcount increases.
All these developments underscore the significant opportunity for players who have modern technology and who are in a position to drive growth.
Capital One is very well positioned to do that.
We've spent years driving our technology transformation from the bottom of the tech stack up.
We were an original fintech, and we have built modern technology infrastructure and capabilities at scale.
And we're investing to leverage these capabilities to grow and to realize the many benefits of our digital transformation.
We have been on a long journey to drive our operating efficiency ratio down.
We expect that the striking rise in the cost of modern tech talent, on top of our growth investment, will pressure annual operating efficiency in the near term.
But these pressures do not change our belief in the longer-term opportunity to drive operating efficiency improvement powered by revenue growth and digital productivity gains.
Pulling way up, we're living through an extraordinary time of digital change.
Our modern technology stack is powering our performance and our growth opportunity.
It's setting us up to capitalize on the accelerating digital revolution in banking.
And it's the engine that drives enduring value creation over the long term.
We'll now start the Q&A session.
As a courtesy to other investors and analysts who may wish to ask a question, please limit yourself to one question plus a single follow-up question.
And if you have follow-up questions after the Q&A, the investor relations team will be available after the call.
Justin, please start the Q&A.
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compname reports fourth quarter 2021 net income of $2.4 billion.
q4 revenue rose 4% to $8.1 billion.
qtrly net interest margin of 6.60%, up 25 basis points versus q3.
compname reports fourth quarter 2021 net income of $2.4 billion, or $5.41 per share.
compname says common equity tier 1 capital ratio under basel iii standardized approach of 13.1 percent at december 31, 2021.
qtrly earnings per share $5.41.
qtrly provision for credit losses increased $723 million to $381 million versus q3 2021.
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I'm pleased to report another very strong quarter with record revenues at CooperVision and CooperSurgical, driving record earnings and robust free cash flow.
CooperVision's growth was broad-based and led by our daily silicone hydrogel portfolio of lenses and a solid rebound in EMEA.
While our myopia management products also performed really well, and of course, we received the exciting news about regulatory approvals for MiSight in China.
CooperSurgical continued posting great results led by fertility and a nice bump in PARAGARD, helped by buying activity from a price increase.
Moving forward, we expect core operational strength to continue driving strong performance even with challenges from COVID and currency.
With this expectation and the opportunities we're seeing in myopia management, daily silicones, and fertility, we've increased our constant currency revenue guidance for both CooperVision and CooperSurgical and we'll maintain our investment activity to capitalize on the potential for incremental share gains as we move toward fiscal 2022.
Moving to third-quarter results and reporting all percentages on a constant currency basis, Consolidated revenues were $763 million, with CooperVision at $558 million, up 20%, and CooperSurgical at $206 million, up 58%.
Non-GAAP earnings per share were $3.41.
For CooperVision, our daily silicone hydrogel portfolio led the way with all 3 regions posting strong growth.
Particular strength was noted in our daily toric franchises, but daily spheres and multifocals also performed well.
And in a great sign, we've seen a nice uptick in fit data for MyDay and clariti, which bodes well for share gains and future growth.
Within the regions, the Americas grew 16%, led by MyDay and clariti and continued improvement in patient flow.
EMEA grew a healthy 24% as consumer activity returned in the region, and we took share.
1 in EMEA, and we're seeing the benefits of increasing patient flow, So, we'll continue investing to support the reopening activity happening in many of the European markets.
Asia Pac grew 18%, led by a slow but steady improvement in consumer activity.
For us, a significant portion of Asia Pac is driven by Japan.
And although consumer activity remains somewhat muted, we're performing well and taking share, and we're well-positioned to capitalize on future opportunities given our recent product launches.
Moving to category details.
Silicone hydrogel dailies grew 31% and with MyDay and clariti both performing well.
MyDay, in particular, continues taking share, led by strength in MyDay toric in all regions.
For our FRP portfolio, Biofinity continued its solid performance led by Biofinity Energys and Biofinity toric multifocal.
Regarding product expansions and launches, we remain very active.
We're finishing the launch of clariti, sphere, and the MyDay second base curve sphere in Japan.
We're rolling out Biofinity toric multifocal in additional markets.
We're rolling out an expanded toric range for MyDay, giving it the broadest range of any daily toric in the world.
And we're also completing the rollout of extended toric ranges for clariti and Biofinity.
We've also started prelaunching activity for MyDay multifocal with the launch -- with a full launch on target for the U.S. and other select markets in November.
Feedback on this lens remains extremely positive, including from fitters commenting that our OptiExpert fitting app has the highest fit success rate of any multifocal on the market.
Recent data shows that over 90% of contact lens wearers over the age of 40 expect to continue wearing lenses with the biggest challenge being finding a good multifocal.
Given the feedback we've been receiving, we believe MyDay will be the best multifocal on the market and combined with the fact that it's joining an already highly successful MyDay sphere and toric, we're very optimistic about its success.
Moving to myopia management.
Our portfolio grew a robust 90% this quarter to $18 million, with MiSight up 187% to $5 million and ortho-k products up 68%.
As a global leader in the myopia management space, our portfolio is the broadest in the industry, comprised of MiSight, the only FDA-approved myopia control product, our broad range of market-leading ortho-k lenses, and our innovative SightGlass Vision glasses.
We continue targeting $65 million in myopia management sales this year, including MiSight reaching $20 million.
Regarding MiSight, there was a lot of positive activity this quarter as we continue capitalizing on our first-mover advantage.
We received regulatory approval in China, and we're extremely excited about that opportunity.
The approval requires lenses to be manufactured post-approval.
So, we've quickly initiated production and packaging, and plan to seed the market starting in early fiscal Q1 with a full launch in fiscal Q2 of next year.
As part of this, we're immediately ramping up marketing efforts and working quickly to ensure the product is positioned for success.
Myopia rates are very high in China, So, the market potential is significant.
As an example, it's estimated that over 80% of high school kids are myopic, So, treating children at a younger age is of high importance in the country.
Outside of China, we continue making great progress with our large retailers and buying groups.
Our pilot programs are live and expanding, and we've finally been able to resume in-person training in many markets, including in the U.S.
We now have over 40,000 children wearing MiSight worldwide, and that number is growing quickly.
Additionally, the average age of a new MiSight wearer remains 11, So, this treatment is bringing children into contact lenses at a much younger age.
Lastly, on MiSight, we did see momentum pick up even more in August, including here in the U.S., So, we're bullish for a strong Q4.
Regarding our other myopia management products, we had a solid quarter for ortho-k driven by our broad product portfolio and from the halo effect we're seeing with MiSight.
And we continue making progress with our SightGlass myopia management glasses, preparing for several upcoming launches later this calendar year.
We've also submitted our application to the FDA for approval for MiSight as a myopia management treatment and expect to receive initial feedback within a couple of months.
In the meantime, as the myopia management market continues developing, we're definitely seeing the value of offering multiple options to eye care professionals, So, we look forward to expanding our offerings and availability.
To wrap up on myopia management, our innovation pipeline is very healthy with eight focused pipeline products.
Our sales and marketing efforts are proving successful and our focus on leading with clinical data and providing the best and broadest portfolio in the market, has us in an excellent position for continued success.
To conclude on vision, our business is doing really well.
The back-to-school season is healthy, new fits are doing well, and we're excited about our existing products and upcoming launches.
On a longer-term basis, the macro growth trends remained solid, with roughly 33% of the world being myopic today, and that number is expected to increase to 50% by 2050.
Given our robust product portfolio, new product launches, myopia management momentum, and strong fit data, we're in great shape for long-term sustainable growth.
This was an outstanding quarter with record revenues of $206 million.
Fertility, in particular, continued to perform exceptionally well, growing 72% year over year to $83 million.
Strike was seen around the world and throughout the product portfolio, including from consumables, capital equipment, and genetic testing.
Some areas of strength included growth in media, for pets, needles, incubators, and embryo transfer catheters, along with another very strong quarter from RI Witness, our proprietary automated lab-based management system that clinics implement to maximize safety and security by optimizing their lab practices.
We're also benefiting from increased utilization of our artificial intelligence-based genetic testing platform, which increases the doctor's ability to select the best embryos for transfer.
Similar to last quarter, we're continuing to see COVID impact the market, but share gains and improving patient flow in most countries are driving our results.
Regarding the broader fertility market, the global landscape remains fragmented with significant geographic diversity.
And with an addressable market opportunity of well over $1 billion and mid- to upper-single-digit growth, this is a great market for us.
It's estimated that one in eight couples in the U.S. has trouble getting pregnant due to a variety of factors, including increasing maternal age.
And that more than 100 million individuals worldwide suffer from infertility.
Given the improving access to fertility treatments, increasing patient awareness, greater comfort discussing IVF and increasing global disposable income, this industry should grow nicely for many years to come.
So, overall, in fertility, our portfolio and market positioning are excellent.
We remain in a great spot for future share gains with improving traction in key accounts.
We're seeing continued reopening activity around the world, and the industry has great long-term macro growth drivers.
For all these reasons, we remain very bullish on this part of our business.
Within our office and surgical unit, we grew 50% with PARAGARD up 51% and office and surgical medical devices up 49%.
For PARAGARD, we implemented a roughly 6% price increase toward the end of the quarter, which resulted in a buy-in of roughly $4 million.
This will impact our Q4 performance, but the price increases are long-term positive noting with contracts and reimbursement timing, the price increase rolls in over the next couple of years.
Within medical devices, several products performed well, including EndoSee Advance, our direct visualization system, for evaluation of the endometrium and our portfolio of uterine manipulators.
To wrap up on CooperSurgical, this was another excellent quarter, and it was great to exceed $200 million in sales for the first time ever.
Similar to CooperVision, we have powerful macro trends supporting our underlying growth and remain confident in our ability to continue delivering strong results.
Third-quarter consolidated revenues increased 32% year over year or 28% in constant currency to $763 million.
Consolidated gross margin increased year over year to 68.3%, up from 66.3% with CooperVision posting higher margins driven by product mix and currency, and CooperSurgical posting higher margins from product mix tied to the significant year-over-year growth in fertility and PARAGARD.
Opex grew 28% as sales increased with a rebound in revenues, along with higher sales and marketing expenses associated with investments in areas such as myopia management.
Consolidated operating margins were strong at 26.6%, up from 23.2% last year.
Interest expense was $5.6 million and the effective tax rate was 13.5%.
Non-GAAP earnings per share was $3.41 with roughly 49.8 million average shares outstanding.
Free cash flow was very strong at $180 million, comprised of $224 million of operating cash flow, offset by $44 million of capex.
Net debt decreased to $1.5 billion and our adjusted leverage ratio improved to one and a half times.
Overall, this was a very strong quarter, and we exceeded our financial performance expectations.
We continue monitoring and evaluating the scope, duration, and impact of COVID-19 and its variants.
And while this remains a risk factor, our visibility is sufficient to provide the following update to our guidance.
For the full fiscal year, we're increasing our constant currency guidance for both CooperVision and CooperSurgical and maintaining our non-GAAP earnings per share guidance.
Specific to Q4, consolidated revenues are expected to range from $730 million to $760 million, up 7% to 11% in constant currency, with CooperVision revenues between $540 million and $560 million up 6% to 10% in constant currency, and CooperSurgical revenues between $190 million and $200 million, up 8.5% to 14% in constant currency.
Non-GAAP earnings per share is expected to range from $3.24 to $3.44.
To provide color on this guidance, currency moves since last quarter have reduced the benefit of the full-year FX tailwind from 3% to 2.5% for revenues, and 7% to 5% for EPS.
With respect to Q4, this equates to reducing revenues by $10 million in CooperVision and $2 million at CooperSurgical, and reducing earnings per share by $0.14.
CooperVision is offsetting some of the impact with expected strength in daily silicone and myopia management sales, while CooperSurgical is expecting continued strength, although incorporating the Q3 PARAGARD buy-in of $4 million and hopefully some conservatism regarding COVID's impact on elective procedures.
Consolidated gross margins for the fiscal year are expected to be around 68%, with fiscal Q4 gross margins expected to be around 67.5%, driven primarily by currency.
Operating expenses are expected to be slightly lower sequentially, but similar to fiscal Q3 on a percentage of sales basis, as we continue investing in multiple areas such as myopia management and fertility.
Our Q4 tax rate is expected to be around 11%.
And lastly, our free cash flow continues to improve, and we're now expecting roughly $550 million for the full year.
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q3 non-gaap earnings per share $3.41.
sees q4 2021 non-gaap earnings per share $3.24 to $3.44.
sees fiscal 2021 total revenue $2,893- $2,923 million (16% to 18% constant currency).
sees fiscal q4 2021 total revenue $730 - $760 million (7% to 11% constant currency).
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Let me start by providing some key takeaways.
First, we continue taking share in the global contact lens market, with CooperVision being flat for calendar Q3 against the market being down 3%.
We're having success with our strong daily silicone hydrogel portfolio, with unique products like Biofinity Energys, and with several product launches.
Second, CooperSurgical outperformed with fertility, PARAGARD, and medical devices all exceeding expectations.
In particular, we're taking share in the fertility market, where we're seeing strong momentum.
Third, our myopia management portfolio comprised of MiSight and Ortho K lenses performed extremely well, including MiSight being up 73%.
So we're taking share, launching products, and investing intelligently, including helping expand the pediatric optometry marketplace.
Our teams are executing at a very high level, and we expect that to continue.
Moving to the numbers and reporting all percentages on a constant-currency basis, we posted consolidated revenues of $682 million in Q4, with CooperVision revenues of $506 million, down 3%; and CooperSurgical revenues of $175 million, down 4%.
Non-GAAP earnings per share were $3.16.
For CooperVision, the Americas were up 3%, led by strength in MyDay and Biofinity and some rebound in channel inventory of roughly $10 million.
EMEA was down 6%, which included quarter-end purchasing delays from several large accounts as the region returned to more restrictive COVID-related lockdowns in October.
Asia Pac was down 8% with COVID-related softness lingering longer into the quarter than we were expecting.
To add a little more color on Asia Pac, we're well-positioned in that region and taking share, but the market has been sluggish.
We are becoming more optimistic, though, as we saw a pickup in October and November, driven by strong MyDay sales.
Overall, for the full quarter, revenues came in roughly where we expected with COVID continuing to present challenges, but we're managing through it and taking share by executing on product launches and expanding our key account relationships.
Moving to some additional quarterly numbers.
Our silicone hydrogel dailies were up 1% in Q4, led by strength in torics and a strong rebound in MyDay sphere sales.
We're seeing daily silicones as the clear winner right now as health and wellness trends continue to drive adoption, and this bodes well for us given our strong portfolio.
Additionally, we're now fully unconstrained on MyDay, so we're able to aggressively launch the product around the world, especially the toric, which is still relatively early in its launch stage.
Biofinity and Avaira combined to be flat for the quarter, with strength noted in Biofinity toric and Energys.
Energys continues to be a strong performer, growing double digits.
It was launched a few years ago, probably a little ahead of its time.
But its innovative lens design that uses digital zone optics to help alleviate eye fatigue from excessive screen time is certainly catching on now as it's addressing an important need in today's digital world.
Moving to our product launches.
We remain incredibly busy with MyDay sphere and toric being launched or relaunched in many markets around the world.
Biofinity toric multifocal and clariti's extended daily toric range continuing their successful launches and the launch of MiSight.
One point to highlight is how incredibly active we are in the daily silicone hydrogel space right now, probably busier launching products than anyone, and we expect this to continue throughout 2021.
Given there still exists roughly $2.4 billion in traditional daily hydrogel sales worldwide, there's a significant multiyear trade-up opportunity for us and our industry.
The only FDA-approved myopia management contact lens clinically proven to slow the progression of myopia in children.
Things are going incredibly well.
We now have roughly 25,000 kids around the world wearing MiSight, including over 1,000 in the U.S., and the momentum when new fits is strong.
But we already have 2,100 optometrists certified to fit the lens and 1,400 more in the process of being certified.
We've also recently launched in Taiwan and Russia, and the early feedback is very positive.
launch, including the average age for a new MiSight wearer is 11 years old.
Getting fits in this age range is fantastic as the average age for fitting a new wearer in regular contact lenses is 17, which means we're getting an extra six years' worth of revenue.
Furthermore, 70% of kids being fit in MiSight are 12 and under.
So we're changing the overall perception of what age kids can be fit in contact lenses.
Regarding sales, even with continuing COVID challenges, our myopia management portfolio, including MiSight and Ortho K lenses, grew 39% to $13 million.
Within these results, MiSight grew 73% to $2.5 million and Ortho K grew 33%, which included $1.3 million of revenue from last quarter's acquisition of GP Specialties.
For this coming year, even with COVID impacting the market, we're continuing to target $25 million in global MiSight sales, which is growth of roughly 250%.
We're also targeting strong growth in our Ortho K franchise, driven by positive developments such as the recent receipt of European CE mark approval for our Paragon lenses.
When looking at the global myopia management market, we're at the forefront of an extremely exciting pediatric optometry category.
Myopia management is in its infancy.
But as we discussed last quarter, there's a clear path to a market that we expect will ultimately be well over $5 billion annually for manufacturers.
We still have a lot of work to do, and we're investing in sales and marketing programs, new launches, regulatory approvals, and R&D activities to really help drive the market forward.
This approach is clearly working, and it's great to keep hearing optometrists talk about MiSight as standard of care for their pediatric patients.
As trained professionals, optometrists know that reducing the progression of myopia brings many benefits, including reducing the risk of serious eye disease later in life, such as retinal detachment, cataracts, and glaucoma.
To conclude our vision, let me touch on the global contact lens market.
We're seeing optometry offices mostly open around the world, and we're frequently hearing that they're fully booked with appointments running through January.
Having said that, patient throughput remains below pre-COVID levels as offices work to get more efficient with COVID safety protocols and managing staffing challenges.
From a consumption perspective, wearers are returning to their normal wearing and ordering habits.
But new fits are running roughly 90% of pre-COVID levels on a global basis, and that's the challenge.
and in markets like China, and it's improving everywhere, but eye care professionals are still struggling to meet demand.
We're not seeing any signs that demand is disappearing, though, so we believe it's only a matter of time before new fit activity returns to pre-COVID levels and the pent-up demand is addressed.
On a longer-term basis, the underlying growth drivers for our industry remains strong and may actually be improving with the macro trend of people spending more time on electronic devices.
With roughly one-third of the world myopic, and this is expected to increase to 50% by 2050, combined with a continuing shift to daily silicone hydrogel lenses, geographic expansion, and strong growth in torics and multifocals, our industry has a very bright future.
And for CooperVision, our strong product portfolio, momentum within the myopia management space, and strong new fit data puts us in a great position for long-term sustainable growth.
Revenues rebounded faster than expected to $175 million for the quarter.
Although down 4%, we exceeded expectations in a challenging market environment and expect solid performance moving forward.
Starting with our fertility business.
Revenues rebounded nicely and were only down 2% year over year.
We're taking market share, and we're well-positioned for future gains with a strong product portfolio and improved traction with key accounts.
Within products, our consumable portfolio grew this quarter, led by our RI Witness system.
This is an RFID lab-based management system that helps fertility clinics automate their processes by identifying, tracking, and recording patient samples throughout the IVF process.
Labs are starting to use it as a cornerstone solution to improve safety, reduce errors, improve workflow management, and enhanced compliance of standard operating procedures.
The product almost doubled in revenue to $2.5 million and with a growing focus on safety and compliance within fertility clinics, we expect this product to continue growing nicely.
Our genomics business also returned to growth this quarter as testing volume picked up, and our media products also grew.
The only softness we saw was in capital equipment, which declined against a very tough comp from last year.
From a fertility market perspective, we're still seeing COVID negatively impact patient flow and some important countries like India still have clinics shut down or are operating with minimal patient volume.
But the good news is we're seeing patient flow improving, and we believe we'll see IVF cycles return to normal soon.
With this happening, we'll continue expanding our business through in-person and virtual sales and marketing activity, adding sales personnel, and expanding our product offerings.
The fertility market has extremely positive long-term macro growth trends.
And as the global leader in the space, we're intent on helping the industry return to its strong historical growth rates.
Within our office and surgical unit, we were down 5%, slightly better than forecasted.
PARAGARD continued to rebound, down 6% to $50 million against a tough comp from last year due to buy-in activity before price increase.
PARAGARD is another product that is benefiting from the positive wellness trends we're seeing in the U.S. as the only 100% hormone-free IUD on the U.S. market, it offers a fantastic long-lasting birth control option that addresses the needs and interests of women looking for a healthy alternative.
Sales of the product continued trending in the right direction through November, so we're optimistic we'll see PARAGARD grow year over year in Q1.
Elsewhere, like many medical device companies, we've seen deferred elective procedures steadily rescheduled, and our medical device sales have improved.
We're entering this year in a really nice position with some of our focus products such as INSORB, our patented surgical skin closure device, and EndoSee Advance, our direct visualization system for evaluation of the endometrium positioned to grow nicely as markets rebound.
In conclusion, let me say I'm optimistic about the future.
Our businesses are performing well, and we're taking share.
We're very active with new product launches, and we have fantastic dedicated people driving our businesses forward.
Our fourth-quarter consolidated revenues decreased 1% as reported or 3% in constant currency to $682 million.
Consolidated gross margin increased 70 basis points year over year to 67.7%.
This was driven primarily by currency at CooperVision and efficiency improvements at CooperSurgical, from our successful global manufacturing integration and consolidation efforts.
This quarter was an extremely busy one for our manufacturing teams as we work diligently to finish most of our manufacturing restructuring activity.
This now allows us to minimize costs while optimizing production to more efficiently manage inventory levels and improve margins and cash flow.
We're in a significantly better position with our manufacturing operations rightsized for the current environment, while also being well-positioned to ramp up quickly.
We still have some absorption-related inefficiencies, but we expect these to go away quickly as growth returns.
OPEX was up 4.3% year over year, largely due to planned MiSight investment activity, including sales and marketing, regulatory, and R&D costs.
This resulted in consolidated operating margins of 26.8%, down from 28.5% last year.
This performance slightly exceeded expectations as we continued to effectively managing expenses, balancing costs against investment opportunities.
Interest expense for the quarter was $6.7 million, driven by lower interest rates and lower average debt and the effective tax rate was 11.1%.
Non-GAAP earnings per share was $3.16 with roughly 49.6 million average shares outstanding.
The year-over-year FX impact for the quarter to revenue and earnings per share was a positive $10.6 million and a positive $0.15.
Free cash flow was strong at $111 million, comprised of $218 million of operating cash flow offset by $107 million of CAPEX.
Net debt decreased by $76 million to $1.68 billion, and our adjusted leverage ratio decreased to 2.15 times.
Before moving to guidance, I want to mention an item you'll see disclosed in the tax footnote in our upcoming 10-K.
In November, as part of an internal restructuring to simplify our supply chain, CooperVision's intellectual property and related assets were transferred from Barbados to the U.K. Although this will impact our GAAP financials, including a significant onetime P&L benefit in Q1, along with offsetting adjustments over the next 10-plus years, we will exclude these entries from our non-GAAP results to ensure transparency.
We do not expect this having a material impact on our non-GAAP tax rate over this period.
We were hoping to give full-year guidance but the surging COVID cases in Europe and in the U.S., make that extremely difficult.
So we're providing only Q1 guidance at this time.
This includes consolidated revenues of $642 million to $670 million, down 1% to up 4% or down 3% to up 2% in constant currency.
CooperVision revenue of $482 million to $502 million, down 1% to up 4% or down 3% to up 1% in constant currency.
And CooperSurgical revenue of $160 million to $168 million, down 1% to up 4%, both as reported and in constant currency.
Non-GAAP earnings per share is expected to be in the range of $2.66 to $2.86.
As compared to last year, we expect the midpoint of our non-GAAP earnings per share guidance to be up $0.07 due to a positive $0.21 currency impact, offset by MiSight investment activity and slightly lower gross margins tied to unfavorable manufacturing absorption.
Below the line, we expect lower interest expense to be roughly offset by a higher effective tax rate.
Lastly, on cash flow.
We made significant progress completing our multiyear capacity expansion program and expect solid improvement in free cash flow moving forward as operating cash flow improves and CAPEX reduces.
In conclusion, even with COVID, we expect to start the year off well.
We have strong product lines, solid manufacturing, and distribution capabilities, growing key account relationships, plenty of MyDay capacity, and a dynamic myopia management business.
We plan to continue taking market share, and we look forward to COVID vaccines and better treatments returning markets to normal.
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compname reports q4 non-gaap earnings per share $3.16.
q4 non-gaap earnings per share $3.16.
sees q1 non-gaap earnings per share $2.66 to $2.86 including items.
sees fiscal q1 2021 total revenue $642 million - $670 million.
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Mark Keener, our vice president of investor relations, is also in the room today.
As Ellen mentioned, I'll make a few opening comments, and then Bill will address a few details about this quarter's results.
And then we'll begin the Q&A session.
Obviously, financial and operating results were outstanding, but the context for describing them as notable meant something different.
For the past year, we've been integrating Concho, improving underlying metrics across the business and creating the most competitive E&P for the energy transition.
The significance of this quarter's performance is that it represents the post Concho go-forward baseline for the company.
On a run rate basis, the integration is essentially complete.
We've captured the announced $1 billion of synergies and savings from actions the company took in connection with the transaction, all ahead of schedule.
We're unhedged, but even more importantly, our torque to upside is helped by having high conversion of revenue to income and cash flow.
The core executables of our global operating plan are delivering as expected.
We'll close out 2021 as a stronger company compared to any time in the past decade.
Every aspect of our triple mandate is moving in the right direction.
Our underlying portfolio cost to supply is improving.
Our overall GHG intensity is lower.
Our emissions intensity reduction targets are more stringent.
Underlying margins are expanding, and our trailing 12-month return on capital employed is headed toward an estimated 14% by year-end, reflecting the benefit of more than just stronger commodity prices.
Between now and year-end, our top priority is closing the Shell transaction, which we expect to occur in the fourth quarter.
Once we close, we will be working diligently to integrate these properties and capture efficiencies in a similar fashion to what we've achieved through the Concho integration.
In addition to layering in these properties on top of our existing high-performing platform, we're continuing to high-grade our portfolio and optimize the business drivers everywhere.
The setup for next year is, well, notable.
We're now in the process of setting our 2022 capital plans, which we expect to announce in early December.
Directionally, we don't anticipate a significant departure on capex from what we included in our June update excluding Shell.
In June, we provided an outlook based on a roughly $50 per barrel price that included a modest ramp in the Lower 48 to reactivate our optimized plateau plans, some incremental base Alaska investment and some longer-cycle low cost of supply investments in Canada, the Montney and in Norway.
Since June, we see some inflation pressures, especially in the Lower 48.
However, at this point, we'd expect to adjust scope modestly in order -- in response to maintain our base capital at a level that is roughly consistent with our June update.
And then, of course, we'll add capex for the Shell properties once we've brought them into the portfolio.
As we finalize our 2022 plans, we're watching the macro closely, keeping an eye on inflation and potential OBO pressures and undertaking our typical capital high-grading processes.
It goes without saying the market certainly appears to be more constructive, but we must always remember that this is an incredibly volatile business.
But there's more to come on that in December.
We believe we're entering a very constructive time for the sector, but even so, we know that there will be relative winners.
The relative winners will be companies with the lowest cost of supply investment options, peer-leading delivery of returns on and of capital and visible progress on lowering emissions intensity.
That's what we offer.
Our third quarter represents a glimpse and a strong jumping-off point to what you can expect from ConocoPhillips going forward.
To begin, adjusted earnings were $1.77 per share for the quarter.
Relative to consensus, this performance reflects production volumes that were slightly above the midpoint of guidance, better-than-expected price realizations and lower-than-expected DD&A.
As for the better realizations, we captured a higher percentage of Brent pricing in our overall realized prices.
And as Ryan mentioned, we're unhedged so we're getting full exposure to the current higher prices.
As for DD&A, we're trending lower compared to the previous guidance as a result of positive reserve revisions due to higher prices.
You saw in today's release that we lowered full year 2021 DD&A guidance from $7.4 billion to $7.1 billion.
Excluding Libya, production for the quarter was 1,507,000 barrels of oil equivalent per day, which represents about 2% underlying growth.
Lower 48 production averaged 790,000 barrels a day, including about 445,000 from the Permian, 217,000 from the Eagle Ford, and 95,000 from the Bakken.
At the end of the quarter, we had 15 operated drilling rigs and seven frac crews working in the Lower 48.
Across the rest of our operations, the business ran extremely well.
In particular, our planned seasonal turnaround activity across several regions went safely and smoothly.
This reflects the impact of a decision we're making to convert Concho two stream contracted volumes to a three-stream reporting basis as part of our ongoing efforts to create marketing optionality across the Lower 48.
We expect to convert the majority of our contracts in the fourth quarter.
Reported production is expected to increase by approximately 40,000 barrels a day, and both revenue and operating costs will increase by roughly $70 million.
In other words, this conversion is earnings neutral.
Besides DD&A and production, there were no other changes to 2021 guidance items.
Now, once we've closed the Shell acquisition and can see where the ongoing US tax legislation conversation lands, we'll provide an updated earnings and cash flow sensitivities that consider such factors as projected 2022 price ranges and how those ranges might impact our cash taxpaying position in various jurisdictions around the globe.
Coming back to third quarter results.
Cash from operations was $4.1 billion, which was reduced by about $200 million for nonrecurring items, so a bit higher than the average of external estimates on an underlying basis.
Free cash flow was almost $3 billion this quarter, and on a year-to-date basis, this is about $6.5 billion.
Through the first nine months of the year, we've returned $4 billion to shareholders, and we're on track to meet our target of returning nearly $6 billion by the end of 2021.
This is through a combination of our ordinary dividend and buybacks.
So to summarize, as Ryan said, it was a notable quarter.
The company is running exceptionally well, and we've achieved a significant reset of the base business post Concho.
That creates a powerful platform for entering next year.
We're focused on closing the Shell Permian acquisition so that we can begin the work of getting those properties fully integrated into the business, setting our capital plans for 2022, maintaining a leading position of returns on and of capital and lowering our emissions intensity.
That's the triple mandate.
That's what ConocoPhillips is all about.
And we look forward to providing additional information in December.
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q3 adjusted earnings per share $1.77 excluding items.
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We have Ryan Lance, our chairman and CEO; Bill Bullock, executive vice president and chief financial officer; Dominic Macklon, executive vice president of strategy, sustainability, and technology; Tim Leach, executive vice president of Lower 48; and Nick Olds, executive vice president for global operations.
And finally, we'll also make reference to some non-GAAP financial measures today.
So, 2021 was a truly remarkable year for ConocoPhillips.
Our operating performance around the globe was outstanding, we generated strong returns on and of capital for our shareholders and closed on two significant, highly accretive acquisitions in the heart of the Permian Basin.
Our exceptional results last year are directly attributable to the talent and dedication of our global workforce.
We produced 1.6 million barrels per day and brought first production online at GMT2 in Alaska, the third Montney well pad, and the Malikai Phase 2 and S&P Phase 2 projects in Malaysia.
We also completed the Tor II project in Norway and achieved all of this with excellent cost, schedule, safety, and environmental performance.
Financially, we achieved a 14% full-year return on capital employed or 16% on a cash-adjusted basis and generated $15.7 billion in CFO, with over $10 billion in free cash flow.
And we returned $6 billion to our shareholders, representing 38% of our cash from operations.
We also continued our rigorous portfolio optimization work, completing the truly transformative Concho and Shell Permian acquisitions and further high-grading our asset base around the world.
In the Asia Pacific region, we exercised our pre-emption right to acquire an additional 10% in APLNG and announced the sale of assets in Indonesia for $1.4 billion.
In the Lower 48, we generated $0.3 billion in proceeds from the sale of noncore assets last year, and last week, we signed an agreement to sell an additional property set, outside of our core areas for an additional $440 million.
Collectively, these transactions reduced both the average cost of supply and the GHG intensity of our more than 20-billion-barrel resource base and we're well down the road toward achieving our $4 billion to $5 billion in dispositions by 2023.
In early December, consistent with our 10-year plan and capital allocation priorities, we announced a returns-driven capital budget for 2022 that's expected to deliver modest growth this year.
We also introduced a new variable return of cash, or VROC, tiered to our distribution framework and provided a full-year target of $7 billion in total returns of capital to our shareholders.
Based on current prices on the forward curve, we've increased the target to $8 billion, with the incremental $1 billion coming in the form of increased share repurchases and a higher variable return of cash.
The $0.30 per share VROC announced for the second quarter represents a 50% increase over our inaugural variable return to shareholders that we paid this quarter.
Now, to put the $8 billion in perspective, it equates to an increase of more than 30% from the $6 billion returned last year and a greater than 50% increase in projected cash return to shareholders.
Our three-tier distribution framework provides a flexible and durable means to meet our returns commitment through the price cycle and truly is differential to others in this sector as our returns commitment is based on a percentage of CFO and not free cash flow.
And as you know, we are guided in everything we do by our triple mandate.
We must reliably and responsibly deliver oil and gas production to meet energy transition pathway demand.
We need to generate competitive returns on and of capital for our shareholders and achieve our Paris-aligned net-zero ambition by 2050.
Just as I'm very proud of the excellent operational and returns-focused performance we delivered in 2021, I'm equally pleased about the progress we have made in support of the third pillar of our mandate.
We increased our medium-term emissions intensity reduction target to 40% to 50% by 2030 and expanded it to include both gross operated and net equity production.
As a reminder, we're also committed to further reducing our methane emissions and achieving our zero routine flaring ambition by 2025.
And as highlighted in our December release, we've allocated $0.2 billion of this year's capital program for projects to reduce the company's Scope 1 and 2 emissions intensity and investments in several early stage, low-carbon opportunities that address end-use emissions.
We strongly believe that this level of focus on and performance toward is fully realizing our triple mandate as ConocoPhillips is very well positioned to not just survive through the energy transition, but to thrive regardless of the pathways it takes.
While we're on the topic of energy transition, I'd like to touch on the macroenvironment.
Commodity prices today reflect global energy demand returning to pre-pandemic levels, along with supply being impacted by decreased investment in oil and gas over the past couple of years, concerns about inventory levels, and the amount of available spare production capacity in the system.
All these factors demonstrate the ongoing importance of our sector to the global economy today and for the foreseeable future.
It's becoming increasingly clear that the energy transition isn't going to happen with the flip of a switch.
What people and businesses around the globe need is a managed and orderly transition, but that's not what the world is seeing to this point.
Supply and demand balances are fragile at the moment, likely driving continued volatility and the current commodity price situation in Europe may be providing a cautionary signal.
The simple reality is that most alternative energy sources still have a long way to go toward becoming as scalable, reliable, affordable, and accessible as the world needs them to be, which brings me back to our triple mandate and the importance of performing well across all three of the pillars, for our shareholders and for the people in the world who need and use our products.
Looking at fourth-quarter earnings, we generated $2.27 per share in adjusted earnings.
This performance reflects production above the midpoint of guidance and strong price realizations, as well as some commercial and inventory timing benefits, partially offset by slightly higher costs in DD&A.
Lower 48 production averaged 818,000 barrels of oil equivalent per day for the quarter, including 483,000 from the Permian, 213,000 from the Eagle Ford and 100,000 from the Bakken.
As previously communicated, our Permian and overall Lower 48 production were both increased roughly 40,000 barrels of oil equivalent per day in the quarter due to the conversion from two- to three-stream accounting for the acquired Concho assets.
At the end of the year, we had 20 operated drilling rigs and nine frac crews working in the Lower 48, including those developing the acreage we recently acquired from Shell.
As Ryan touched on earlier, operations across the rest of the portfolio also ran extremely well last year with our GMT2 project in Alaska producing first oil in the fourth quarter as planned.
Turning to cash from operations, we generated $5.5 billion in CFO, excluding working capital, resulting in free cash flow of $3.9 billion in the quarter.
For the full year 2021, we generated $15.7 billion in CFO, $10.4 billion of free cash flow, and returned $6 billion to shareholders.
In addition to the asset dispositions Ryan covered, we also sold 117 million shares we held in Synovis in the year, generating $1.1 billion in proceeds that we used to fund repurchases of our own shares.
This left us with a little over 90 million Synovis shares at the end of the year, which we intend to fully monetize by the end of this quarter.
We ended the year with over $5 billion in cash, maintaining our differential balance sheet strength, even after completing the all-cash acquisition of Shell's Delaware Basin assets.
So, to recap, it was not only a strong quarter but one that also bodes very well for 2022 and future years.
We continue to optimize the portfolio.
Our businesses are running very well around the globe, and we have had an overall reserve replacement ratio of nearly 380%, establishing an incredibly powerful platform for the company as we head into this year and beyond.
Our cash flow performance and leverage to prices have substantially improved over the past couple of years as demonstrated by our fourth-quarter results and expect it will continue to improve as we begin including the newly acquired Delaware assets in our consolidated results this quarter.
Now, demonstrating this point and appreciating that it's helpful for the market to have an accurate sense of our stronger CFO generating capacity, at a WTI price of $75 a barrel with a $3 differential to Brent and a Henry Hub price of $3.75, we estimate our 2022 full-year cash from operations would be approximately $21 billion, which reflects us reentering a tax-paying position in the U.S. this year at those price levels.
And our free cash flow for the year would be roughly $14 billion.
And of course, we continue to be unhedged across our global diverse production base, so we expect to fully capture the upside of the current price environment.
We provided updated sensitivities in today's supplemental materials to help estimate how much earnings and CFO are projected to change this year with market price movements.
So, to sum it up, all that we've shared with you today underscores our readiness to reliably generate very competitive returns for our shareholders as we thoughtfully move forward as a responsible, valuable E&P player in the energy transition.
That is our triple mandate.
It's what we have ConocoPhillips built for and are ready to deliver.
Now, with that, let's go to the operator to start the Q&A.
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compname reports fourth-quarter and full-year 2021 results; increases planned 2022 return of capital to $8 billion and declares quarterly dividend and variable return of cash distribution.
q4 adjusted earnings per share $2.27 excluding items.
announced a $1 billion increase in expected 2022 return of capital to shareholders.
declared both ordinary dividend of 46 cents per share & second-quarter variable return of cash (vroc) payment of 30 cents per share.
completed all-cash shell permian acquisition.
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Joining us today are Pedro Heilbron, Chief Executive Officer of Copa Holdings; and Jose Montero, our Chief Financial Officer.
First, Pedro will start by going over our second quarter highlights, followed by Jose, who will discuss our financial results.
Copa Holdings' financial reports have been prepared in accordance with International Financial Reporting Standards.
In today's call, we will discuss non-IFRS financial measures.
Many of these are discussed in our annual report filed with the SEC.
To them, as always, my utmost respect and admiration.
As many of you know, Raul Pascual decided to take on a new professional challenge and left the company earlier last month.
We're very grateful for the more than 15 years of outstanding work he dedicated to Copa.
Daniel has over 12 years of experience with the company in many areas, including airports, scheduling and most recently, fleet and network planning.
We're very confident in Daniel's ability to lead our Investor Relations group.
As you may remember, in our last earnings call, we discussed two diverging themes happening in Latin America.
On the one hand, some countries, including Panama, were experiencing a downward trend in infection rate, which led to fewer travel restrictions and an improved demand environment.
On the other hand, several other countries continued to struggle with the virus, which led many of them to reimpose air travel restrictions and/or new health requirements affecting demand for international travel.
As of today, the story has not changed much.
Due to the increase in COVID-19 cases, several countries have maintained and, in some cases, increased travel restrictions, which has affected our ability to reinstate capacity.
On the other hand, markets without significant restrictions, mainly to and from the U.S. and certain leisure destinations have continued to recover, which has allowed us to increase capacity quarter-over-quarter while also growing load factors.
In the month of June, we successfully transitioned our Hub of the Americas in Panama back to a six bank connecting structure, which enables cost efficiencies and lets us continue adding back frequencies and destinations.
Moreover, we started to reactivate some of the aircrafts sent to temporary storage during 2020.
Going forward, we assume ongoing vaccination efforts will have a positive effect on COVID-19 infection rates in the region, which we expect will lead to the relaxation of travel restrictions and a faster demand recovery, supporting the capacity deployment for the second half of the year.
Now I'll highlight some of our second quarter results.
In terms of capacity, we reached 48% of second quarter 2019 ASMs compared to 39% in the first quarter.
Load factor came in at 77%, which is an improvement of eight percentage points compared to the first quarter.
Revenues increased by 64% over the previous quarter to $304 million, as a result of the additional capacity, higher load factors and improved yields.
The additional capacity also allowed us to reduce our ex fuel CASM from $0.085 in Q1 to $0.076 in Q2.
We reported an operating profit of $8.7 million in the quarter.
Excluding a $10.4 million passenger revenue adjustment the company would have reported an operating loss of $1.7 million.
Cash accretion averaged $21 million per month, which was better than our expectations, primarily due to stronger sales in the quarter.
We ended the quarter with a cash balance of $1.3 billion and total liquidity of over $1.6 billion.
In terms of our operations and despite the complexity imposed by the multiple biosafety protocols, we're pleased to report an on-time performance of 92% for the quarter and a flight completion factor of 99.5%, which again, places us among the best in the world and is a true testament to our employees' continuous commitment to providing a world-class product to our passengers.
Turning now to Wingo.
We can report that it's now operating six 737-800s compared to the four it operated pre-pandemic.
During the second quarter, Wingo continued its regional expansion with new flights from Panama to San Jose, Costa Rica and from Bogota to Lima, Peru.
And since Q1, it's been operating more capacity than in 2019.
To finalize, I'd like to reaffirm that we have a proven and strong business model which is based on operating the best and most convenient network for intra-Latin America travel from our Hub of the Americas, leveraging Panama's advantageous geographic position with the region's lowest unit cost for a full-service carrier, best on-time performance and strongest balance sheet.
Going forward, the company expects that its Hub of the Americas will be an even more valuable source of strategic advantage.
I hope that you and your families are safe and doing well.
I'd like to join Pedro in acknowledging our great Copa team for all their efforts and great spirit many months of the pandemic.
I will start by going over our second quarter results.
Our capacity came in at $2.9 billion available seat miles, which amounts to about 48% of the capacity operated during the second quarter of 2019.
Load factor came in at an average of 77% for the quarter.
We reported a net profit of $28.1 million or $0.66 per share.
Excluding special items, we would have reported a net loss of $16.2 million or a loss of $0.38 per share.
Special items for the quarter are comprised mainly of an unrealized mark-to-market gain of $33.9 million, related to the company's convertible notes issued in 2020 and $10.4 million in revenues related to unredeemed tickets, which corresponds to sales made during 2019 and early 2020.
We reported a quarterly operating profit, which came in at $8.7 million.
On an adjusted basis, not including the $10.4 million in unredeemed ticket revenues, we had an adjusted operating loss of $1.7 million for the quarter.
It's worth noting that we achieved this result while operating at 48% of our pre-COVID capacity.
Unit costs, excluding fuel for the second quarter came in better than the first quarter at $0.076 per ASM, driven by quarter-over-quarter capacity growth as well as our continued focus on maintaining the savings achieved during the past year.
We continue with our cost savings initiatives, and we are targeting to achieve our unit cost below $0.06 once we reach 100% of our pre-COVID-19 capacity.
Aside from our cost performance, our operating results for the quarter were driven primarily by our yields, which at $0.119 on an underlying basis, came in 1% better than those in Q2 2019.
We also achieved cash accretion of approximately $21 million per month for the quarter, which is ahead of our expectation and driven mainly by increased sales during the period as well as some timing of operational cash outflows.
As a reminder for our cash accretion measure, we exclude all extraordinary proceeds from asset sales but include capex and the payment of our financial obligations.
I'm going to spend some time now discussing our balance sheet and liquidity.
As of the end of the second quarter, we had assets of close to $4.1 billion and our cash, short and long-term investments ended at $1.3 billion.
We also ended the quarter with an aggregate amount of $345 million in unutilized committed credit facilities, which added to our cash brought our total liquidity to more than $1.6 billion.
In terms of debt, we ended the quarter with $1.6 billion in debt and lease liabilities, similar levels to the ones reported for the end of the first quarter.
Turning now to our fleet.
During the second quarter, we finalized the sale and delivery of three Embraer-190s.
And in the month of July, we delivered the last remaining Embraer-190 aircraft in our fleet.
During the month of July, we also entered into an agreement for the sale of six 737-700s and decided to keep in our fleet the remaining six 737-700s.
We ended the second quarter with 81 aircraft.
68 737-800s and 13 737-MAX9s.
In these figures, we include our 737-800s that were sent to temporary storage during 2020.
During the fourth quarter, we expect to receive two more 737 MAX 9s and considering we are now keeping the six 737-700s, we expect to end the year with a total of 89 aircraft.
As to our outlook for the rest of 2021, we're still in an uncertain unpredictable demand and operating environment.
And as such, we will not be providing full year guidance.
However, based on preliminary results for the month of July, and the current state of the demand environment and air trial restrictions that can provide the following outlook for the third quarter of 2021.
We -- We expect capacity to be approximately 70% of Q3 2019 levels at about $4.5 billion ASMs, revenues to be approximately 58% of Q3 2019 levels at about $415 million.
We expect our CASM ex fuel to be approximately $0.66, a decrease of 14% versus the second quarter.
Given these operating assumptions, an all-in fuel price of $2.15 per gallon, as well as the incremental capex that we will incur during the quarter to reactivate our fleet, we expect to be cash neutral for the third quarter.
And with that, we'll open the call to some questions.
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q2 earnings per share $0.66.
q2 loss per share $0.38 excluding items.
qtrly adjusted basic loss per share $0.38.
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I'm Rebecca Gardy, Vice President of Investor Relations.
A transcript of this earnings conference call will be available within 24 hours at investor.
Turning to slide 3.
These statements rely on assumptions and estimates, which could be inaccurate and are subject to risk.
On Slide 4, you will see our agenda.
With us on the call today are Mark Clouse, Campbell's President and CEO; and our Chief Financial Officer, Mick Beekhuizen.
Mark will share his thoughts on our overall first quarter performance and in-market performance by division.
Mick will discuss the financial results of the quarter in more detail and review our guidance for the second quarter.
We will close the call with an analyst Q&A.
I know I am grateful this year for the entire Campbell organization, especially our colleagues in the manufacturing plants and our distribution teams who have been producing and shipping to meet the higher demand the pandemic has brought, while prioritizing the safety of our people and following our heightened in-plant protocols.
Our strong top-line growth combined with gross margin expansion and value capture synergies, despite the impact of ongoing COVID-19 related costs, led to better than expected adjusted EBIT growth, up 18%, and a 31% increase in adjusted earnings per share to $1.02 per share.
It also was a strong executional quarter where we were able to strengthen supply levels to allow our retailers to improve inventory going into the crucial soup and holiday season.
In addition, we announced that our Board approved a 6% increase in our quarterly dividend, reflecting the Company's strong earnings performance, cash flows and increasing confidence in our long-term growth prospects as well as our continued commitment to shareholder returns.
Organic sales in the first quarter increased 8%, led by 12% organic sales growth in Meals & Beverages reflecting our continued investment in our brands to attract and retain new households as retailers also rebuilt inventory levels.
Turning to our Snacks Division, we drove solid growth, with organic sales up 4% reflecting sales increases across the majority of our nine power brands.
Our portfolio of unique and differentiated snacks remained in high demand as in-home consumption rapidly expanded.
We did make some selective strategic decisions to shift promotions from the first quarter to the balance of the year to help ease supply constraints, particularly in the Meals & Beverages division.
While these decisions did generate mixed share results as expected, we exited the first quarter in a much better position on retailer inventories and are seeing accelerating in-market performance as programming is ramping up into our key holiday season.
We expect that pressure of elevated demand on supply will continue in the near term, but we are building supply chain capacity and capabilities to help us better navigate this pressure and maximize availability while protecting and growing share.
For the sixth consecutive quarter, our total Company in-market dollar performance grew in measured channels, increasing 7%, with growth across almost the entire portfolio.
Continuing the momentum from the back half of fiscal 2020, October was the ninth consecutive month in which we grew household penetration versus prior year.
In our first quarter, we attracted millions of new households with the most notable increase coming from younger consumers.
We also continued to see elevated repeat rates with over 70% of households gained since the beginning of the pandemic purchasing our products again.
As we have said on previous calls, we consider this to be an enduring change in behavior and given strengthening consumer trends like quick-scratch cooking and at-home eating and snacking, we remain confident that we will retain a meaningful number of these households beyond the pandemic.
Within the Meals & Beverages division, soup net sales increased 21% with growth in all segments.
This reflects retailer inventory recovery, in-market gains, and moderated promotional activity.
We grew our household penetration in overall soup by 1.3 points.
In addition to gaining new buyers, we are retaining these new buyers as reflected by higher repeat rates.
And, among millennials, we grew share for total US soup by nearly 1 point, including significant growth of 2.7 points on condensed and over 1 point on ready-to-serve, demonstrating the sustained relevance of our core businesses with younger consumers.
Our condensed soups were the highlight of the quarter with double-digit net sales growth, gains in share led by cooking SKUs, and 4 million new households purchasing this quarter versus prior year.
We continued to bring new ideas and recipes to consumers who are cooking more frequently at home.
As these first-time cooks gain more confidence, we believe they will likely continue to use these skills to prepare more meals at home, well beyond the pandemic.
Our recipe solutions continue to resonate with consumers as we saw a 20% increase in overall recipe-related page views in the first quarter compared to the prior year.
Within ready-to-serve, we saw solid consumption growth, but supply pressure and our decision to moderate promotions as previously mentioned, resulted in some short-term share loss.
However, as supply has improved, we are seeing improved trends, supported by our Chunky NFL sponsorship activation, our Slow Kettle Crunch innovation, and our Well Yes!
We expect all these factors to have a very positive impact in the second quarter.
Our Pacific Foods growth engine performed well as we continued to build scale with nearly 22% dollar consumption growth in soup and broth in the quarter.
Pacific soup and broth grew share for the fourth consecutive quarter, including strong gains with millennials.
Pacific has also increased points of distribution and grew household penetration as we launched our first ever national advertising campaign.
Overall, we continue to feel great about the progress we've made against our Win in Soup strategy, as evidenced by our success expanding into millions of new households, attracting younger consumers and growing all of our core brands.
Turning now to the performance of our Snacks power brands, which grew dollar consumption by 6% in the quarter.
The most notable being Late July, which grew consumption sales by 26% and share by nearly 2 points.
We continued to run the brand's first national ad campaign throughout the quarter.
Late July is a great example of how our power brands are helping consumers make the most of their snacking moments.
We take a mainstream segment like tortilla chips and offer a product with higher quality including organic product credentials, highly relevant innovation and world-class marketing to better engage consumers, allowing them to trade up into a better snacking experience.
We have successfully applied this model to other brands as well, such as Kettle Brand chips and Snack Factory Pretzel Crisps, which also had double-digit dollar consumption growth in the quarter.
We also made significant progress on Goldfish in the quarter with both supply and service levels improving.
We have also redirected marketing aimed toward snacking options at home and restored promotional spending toward the end of the quarter.
This is resulting in improved consumption and share in the most recent periods.
We feel very good about our Snacks performance and the steady growth it delivers supported by a very healthy base business.
In addition, we continue to remain on-plan to deliver the value capture synergies that we initially outlined as part of our acquisition of Snyder's-Lance.
Our investment in capacity expansion in both Goldfish and our chips, demonstrates our conviction in the long-term growth potential of our brands.
We are still working through some supply constraints, including a challenge in cookies where the combination of demand and labor impacted by COVID-19 has had some negative impact on supply.
Despite these isolated challenges, we feel very confident in our ability to meet the long-term demand driven by the expected sustained growth of consumer snacking behavior.
Given the rapid growth of the e-commerce channel across foods, I want to touch on our enterprise performance in the quarter.
Our e-commerce in-market dollar consumption results were once again impressive, growing 85% over prior year.
Consumers' use of e-commerce, and particularly click-and-collect for groceries, has increased by a considerable amount these past several months and we believe this trend will continue.
Accordingly, we are investing to strengthen our capabilities and in our support of key partnerships to serve the millions of consumers who are shopping online.
Given our overall financial results and the actions we have taken to start the year, we are well-positioned across our entire portfolio heading into Q2 and the key soup and holiday season.
As Mark just shared, we had a strong start to fiscal 2021 with another quarter of strong sales growth, driven by elevated consumer demand, gross margin expansion, despite the COVID-19 cost headwinds, and robust adjusted EBIT and adjusted earnings per share growth ahead of expectations.
I'll now review our first quarter results in more detail and provide guidance for the second quarter.
For the first quarter, reported net sales increased 7% to $2.3 billion.
Organic net sales increased 8% in the quarter, which excludes the impact of the sale of the European chips business.
Adjusted EBIT increased 18% to $463 million, as higher sales volumes, improved adjusted gross margin performance and lower selling expenses were partially offset by increased marketing and slightly higher adjusted administrative expenses.
Adjusted earnings per share from continuing operations increased by 31%, or $0.24, to $1.02 per share, reflecting an increase in adjusted EBIT as well as a lower net interest expense.
Breaking down our net sales performance for the quarter, organic net sales increased 8% from the prior year.
This performance was driven by a 6 point gain in volume across the majority of our retail brands, offset partially by declines in foodservice.
Lower levels of promotional spending in both segments drove a 2 point gain.
The divestiture of the European chips business negatively impacted net sales in the quarter by a point, and the impact from currency translation in the quarter was neutral.
All-in, our reported net sales were up 7% from the prior year.
Our adjusted gross margin increased by 100 basis points in the quarter to 34.8%.
Favorable product mix, which drove a 30 basis point improvement in our adjusted gross margin, was largely driven by the increased contribution from our soup products within our Meals & Beverages segment.
Separately, we are estimating a 60 basis point gross margin improvement from better operating leverage within our supply chain network as we significantly increased our overall production, primarily within Meals & Beverages.
Net pricing drove a 120 basis point improvement, due to lower levels of promotional spending in the quarter.
Inflation and other factors had a negative impact of 270 basis points driven by cost inflation, as overall input prices on a rate basis increased approximately 2%, as well as other operational costs and continued COVID-19 related costs.
This was partially offset by our ongoing supply chain productivity program, which contributed a 150 basis point improvement, and includes, among others, initiatives within procurement and logistics optimization.
Our cost savings program, which is incremental to our ongoing supply chain productivity program, added 10 basis points to our gross margin expansion.
Moving on to other operating items.
Marketing and selling expenses increased 1% in the quarter to $208 million.
This increase was driven primarily by our planned increased investment in advertising and consumer promotion expenses, which is up 17% versus a year ago.
These investments primarily reflect higher levels of support behind soup, to continue to drive usage, inspire meal solutions, build brand awareness among younger households, and support innovation.
These investments were partially offset by the benefits of our cost savings initiatives, lower marketing overhead, and lower selling expenses.
Adjusted administrative expenses increased $11 million or 9% to $137 million, driven by higher benefit costs and general administrative costs, including incremental consulting charges related to supply chain optimization, as well as inflation, partially offset by the benefits from our cost savings initiatives.
Moving to the next slide, we have continued to successfully deliver against our multi-year enterprise cost savings initiatives.
This quarter, we achieved $15 million in incremental year-over-year savings, inclusive of Snyder's-Lance synergies.
To-date, that brings our savings for the overall program to $740 million.
We expect an additional $60 million to $70million in the balance of fiscal 2021 and we remain on-track to deliver our cumulative savings target of $850 million by the end of fiscal 2022.
To help tie this all together, we are providing an adjusted EBIT bridge to highlight the key drivers of performance this quarter.
As discussed, adjusted EBIT grew by 18%.
This was largely driven by the increase in demand for our products with sales gains contributing $53 million of EBIT growth.
The overall adjusted gross margin expansion of 100 basis points contributed $23 million of EBIT growth, which more than offset higher marketing and selling expenses of $2 million reflecting our investments in A&C, partially offset by lower selling expenses.
The remaining impact of all other items, consisting of adjusted administrative expenses, R&D and adjusted other income in aggregate was nominal.
Our adjusted EBIT margin increased year-over-year by 180 basis points to 19.8%.
The following chart breaks down our adjusted earnings per share growth between our operating performance and below the line items.
Adjusted earnings per share increased $0.24 from $0.78 in the prior-year quarter to $1.02 per share.
Adjusted EBIT had a positive $0.18 impact on adjusted EPS.
Net interest expense declined year-over-year by $25 million, delivering a $0.06 positive impact to adjusted EPS, as we have used proceeds from completed divestitures and our strong cash flow to reduce debt.
The impact from the adjusted tax rate was nominal, completing the bridge to $1.02 per share.
In Meals & Beverages, organic net sales increased 12% to $1.3 billion, reflecting double-digit increases across most of our US retail products, including gains in US soups, inclusive of Pacific Foods soups and broth, Prego pasta sauces, V8 beverages, Campbell's pasta, and Pace Mexican sauces, as well as gains in Canada, partially offset by declines in foodservice.
Volume was favorable in US retail and Canada, driven by increased demand of food purchases for at-home consumption, offset partially by the negative impact on foodservice as a result of shifts in consumer behavior and continued COVID-19 related restrictions.
Net sales of US soup, including Pacific, increased 21% compared to the prior year due to retailers rebuilding inventory for the upcoming soup season, in-market gains in condensed soups and broth and moderating promotional spending.
Operating earnings for Meals & Beverages increased 18% to $333 million.
The increase was primarily driven by sales volume growth and improved gross margin, offset partially by increased marketing investment.
The gross margin performance was impacted by the lower levels of promotional spending and favorable mix, as productivity improvements and improved operating leverage were offset by other operational costs, cost inflation and COVID-19 related costs.
Within Snacks, organic sales increased 4% driven primarily by lower levels of promotional spending as well as healthy velocity on the majority of the base business.
We saw volume gains in fresh bakery products, Late July snacks, Pop Secret popcorn, Pepperidge Farm cookies, Snack Factory Pretzel Crisps, as well as Kettle Brand potato chips, which partially offset declines in Lance sandwich crackers.
Sales of Goldfish crackers were relatively flat in the quarter, as increased demand for family size products were offset by reduced away-from-home consumption.
Operating earnings for Snacks increased 11% driven by lower selling expenses, lower marketing overhead, and sales volume gains, partly offset by higher administrative expenses.
Gross margin performance was consistent with prior year as lower levels of promotional spending were offset by higher net supply chain costs as productivity improvements, cost savings initiatives and improved operating leverage were more than offset by cost inflation and COVID-19 related costs.
I'll now turn to our cash flow and liquidity.
Cash flow from operations was $180 million, comparable to the prior year as changes in working capital were basically offset by higher cash earnings and lower other cash payments.
Cash from investing activities decreased by $341 million, driven by lapping the net proceeds from our divested businesses in the prior year.
The cash outlay for capital expenditures was $74 million, $24 million lower than the prior year driven by discontinued operations, and in line with our previously communicated full-year expectation.
Cash outflows for financing activities were $245 million compared to $453 million a year ago.
The reduced cash outflow reflects lower debt repayments.
Dividends paid in the amount of $108 million were comparable to the prior year, reflecting our current quarterly dividend of $0.35 per share.
We ended the quarter with cash and cash equivalents of $722 million.
I'll now turn to guidance.
As I've reviewed, the Company's strong first quarter fiscal 2021 results were impacted by increased demand stemming from the COVID-19 pandemic.
The impact of the continuing pandemic on the Company's fiscal 2021 results is uncertain and makes it difficult to provide a full year outlook at this time.
Based on our expectation of a continued elevated demand landscape and increased investment in our brands, we are providing the following guidance for the second quarter of fiscal 21.
We expect year-over-year growth in net sales of 5% to 7% as growth more closely aligns with consumption reflecting better inventory, strong programming and improving share positions.
We expect adjusted EBIT growth to be in line with year-over-year sales growth for the quarter as we invest to win the season and keep fueling the retention of new households behind key consumer trends.
We expect the combination of healthy EBIT growth and the benefit of significantly reduced interest expense year-over-year to result in adjusted earnings per share growth of 12% to 15%, or $0.81 to $0.83 per share.
While it remains very difficult to provide anymore direction for the balance of the year, as time has progressed our outlook does continue to strengthen.
In closing, our first-quarter results were a strong start to the year.
I am proud of the continued strong execution by our teams throughout the organization.
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q1 adjusted earnings per share $1.02 from continuing operations.
increases quarterly dividend by 6% to $0.37 per share.
qtrly organic net sales increased 8%.
sees q2 2021 net sales up 5% to up 7%.
sees q2 2021 adjusted earnings per share $0.81 to $0.83.
remains on track to deliver annualized savings of $850 million by end of fiscal 2022.
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I'm Rebecca Gardy, Head of Investor Relations at Campbell Soup Company.
These statements rely on assumptions and estimates, which could be inaccurate and are subject to risk.
As stated in the release from this quarter onwards adjusted net earnings will exclude unrealized mark-to-market gains and losses on outstanding undesignated commodity hedges until such time that the related exposure impacts operating results.
Accordingly, fiscal 2021 adjusted results and guidance for adjusted EBIT and adjusted earnings per share growth rates reflect this change.
Also beginning this fiscal year, the foodservice and Canadian business formerly included in the Snacks segment is now managed as part of the Meals & Beverages segment.
Segment results have been adjusted retrospectively to reflect this change.
On Slide four, you'll see today's agenda.
Mark will share his overall thoughts on our first quarter performance, as well as in-market performance by division.
Mick will discuss the financial results of the quarter in more detail, and then review our guidance for the full-year fiscal 2022.
Organic net sales were down 4% for the quarter, driven by the expected lapping of prior year retailer inventory replenishment, as well as constrained supply in the current quarter.
We were however, up 5% versus fiscal 2020 and consumption was, up 2% versus prior year and up 9% versus two years ago, signaling strong persistent consumer demand.
This dynamic resulted in a 6 point difference in net sales versus consumption in measured channels, a relationship we do not expect to continue through the remainder of the year.
Like many of our competitors and customers, we faced supply chain pressures, particularly around labor constraints and transportation capacity and our net sales results reflect those pressures.
I'm very proud of how our teams navigated costs related to this volatility.
Their strong execution combined with effective pricing actions across both segments, led to adjusted EBIT and adjusted earnings per share results consistent with our expectations and in line or ahead of two years ago.
On Slide seven, with end-market demand remaining strong across both of our segments and the pricing actions we announced at the end of our prior fiscal year now reflected on shelf.
We feel confident about the outlook for the full fiscal year.
We recently announced additional inflation justified pricing actions to offset continuing increases in ingredient and packaging costs, logistics and labor.
This second round of pricing should be effective in January and evident on shelf in the third quarter.
This will result in some added pressure in Q2 as pricing catches up with more recent inflation, but moving into the second half we expect margin progress and earnings recovery as we use all of our available mitigation tools.
To address labor challenges in our network, we have taken specific actions and see early signs of improvement, such as increased on-boarding, lower absenteeism and improved retention.
We've seen a recent uptick in the volume produced across the plants and we expect to begin to rebuild our inventories in the second quarter, but not fully recover until the second half.
Our ingredient and packaging spend, we are now over 85% covered, thereby reducing the variability in the upcoming quarters, while we continue to deliver on our supply chain productivity improvements and our cost savings initiatives.
In addition, we've made selective supply related reductions in marketing and selling investments in the first quarter, which we expect to reverse and fully return to targeted levels as we move into the second half of the year.
Labor and supply challenges are impacting certain brands to a greater extent than others creating some short-term share and consumption pressure.
We expect this to be evident, particularly through the second quarter as we cycle through recovery on labor and supply.
With the strength of our brands in the share gains that have been so consistent and broaden our business over the last two years.
We remain very confident that share positions will improve, once we return to full capacity and investment in the second half of the fiscal year.
Turning to our Meals & Beverages division, I continue to be pleased by the underlying health of the portfolio and the performance of the brands.
Organic net sales were down 6% versus prior year, lapping 11% growth in the prior year and up 5% versus fiscal 2020.
Consumption though flat year-over-year was, up 9% versus two years ago, reflecting the strength of demand for our products.
Turning to Soup on Slide 10, our Win in Soup strategy continues to show positive results.
We retained households and held share in the quarter.
More people are participating and remaining in the soup category than pre-pandemic levels.
Household penetration on ready-to-serve condensed eating and Swanson broth are all ahead of the prior year.
Additionally, compared to prior year the dollar spent per buyer increased as our pricing actions took effect.
While volume per buyer remained flat reflecting the health, relevance and sustained momentum of our brands.
These compelling data points provide evidence that we are retaining our expanded consumer base, despite consumer mobility increasing, returning competition and our inflation driven higher price points.
US Soup consumption grew 2% over elevated levels in the prior year.
Bringing growth versus two years ago to 9%.
Repeat rates and household penetration remained ahead of two years ago on Pacific Foods, ready-to-serve, condensed and Swanson broth.
Condensed dollar share was down slightly in the quarter, however, we continue to be encouraged by evidence to quick-scratch cooking behavior continues.
And our consumer tracking studies, more than a third of the people surveyed indicated that they cook more compared to the prior month.
Additionally, we are seeing the need for quicker meal preparation as consumer shift to hybrid work arrangements, leading to the need for quicker lunches, while working from home and preparing dinners after returning from the workplace.
This is driving an overall increase in our eating share interestingly with our strongest growth in condensed eating coming from millennials.
As you may have noted in more recent periods, we are seeing some recovery of private label in the condensed segment.
This is not unexpected given the recovery from an extended period of supply constraints.
It's important to note, our two-year share gains remain very strong and we remain very confident in our overall competitive position versus private label as we move forward with continued strong support and programing.
Ready-to-serve increased share in the quarter, including over 3 points of share gains among millennials.
Within ready-to-serve Chunky had a very strong quarter, increasing consumption 8% on top of 2% growth in the prior year quarter and grew share by 0.6 points versus prior year.
This is despite elevated promotional levels from competition.
On Swanson broth, we also grew share by 1.6 points, representing the third consecutive quarter of growth as supply recovery continued.
Our Pacific Foods growth engine delivered its eighth consecutive quarter of holding or growing share, driven by sustained momentum on broth, despite remaining supply challenges due to labor pressures paired with high demand.
Turning to Sauces, Prego remain the number one share leader for 30 straight months.
However, short-term material availability is adding pressure on supply and creating more recent pressure on shares, which we expect to improve as we fully recover on inventory in the second half.
Pay share began to improve in Q1 and grew households, compared to prior year.
We see pace continuing to improve throughout the year.
I want to conclude my comments on Meals & Beverage by highlighting an important underlying trends.
Across the Meals & Beverage portfolio, we continued to show strong performance with younger households.
The percentage of buyers under the age of 35 has increased versus the prior year quarter on nearly all key brands.
Specifically on US Soup, the percentage of buyers under 35 increased almost 2 points this quarter and the average age of Campbell Soup consumers are getting younger.
The millennial cohort is the fastest growing segment in condensed eating, ready-to-serve and broth.
Importantly, as we look beyond the current short-term volatility and begin to assess the ability for Meals & Beverages to continue to contribute growth into the future.
This dynamic is a very important indicator and supports our efforts to increase relevance with a new generation of consumers.
Organic net sales were, down 1%, primarily due to labor-related supply constraints, but grew 4%, compared to fiscal 2020, in-market performance was strong growing 5% over the prior year quarter and 9% on a two-year basis.
This dynamic has resulted in low levels of retail inventory that we're working on and expect to recover through the second half of the fiscal year.
Our power brands continue to fuel performance with in-market consumption growth of 6% this fiscal year and 13% on a two-year basis, driven by double-digit consumption growth across the majority of our brands.
We are pleased to see repeat rates on all eight power brands ahead of the prior year and compared to fiscal 2020.
Goldfish performed very well in the quarter, increasing share by half a point and growing consumption high single-digits versus prior year behind strong marketing activation, improved performance in multi-packs and continued successful limited addition flavor innovations resulting in improved base velocities and increased household penetration.
We are winning with consumers, gaining share and driving significant consumption increases.
Innovation continue to be a key growth driver with limited addition Goldfish Jalapeno Popper being the Number One velocity new item launched in the cracker category in the quarter, marking the second quarter in a row, we achieved this metric with our limited edition flavor innovations.
We also continue to increase the relevance additional [Phonetic] kids audience with 60% of new buyers being households with our kids.
We continued to drive share growth on other brands as well, including Snack Factory pretzel crisps by 2.5 points, Kettle Brand potato chips by more than a point and Cape Cod potato chips 2.6 points.
However, as previously mentioned, labor availability on certain Snacks segments is putting pressure on share in several areas.
In particular, cookies Lance crackers, Late July and Snyder's of Hanover pretzels in the quarter.
We are making good progress on recovering, but do expect some of these headwinds to persist into Q2, more broadly recovering in the second half.
As I mentioned earlier, we continue to be pleased with the speed and progress we have made to address the executional pressures experienced last year.
Although, we will still lap a challenging Q2 as we deal with the [Technical Issues] half of the year with progress on margins and shares.
Given our solid first quarter results and their consistency with our expectation [Technical Issues] our full-year guidance.
As previously mentioned while we expect to still have a difficult comparison in Q2 as we lap year ago strength and begin to recover on labor and supply pressures.
We remain very confident in our expectations of positive second half performance and momentum exiting the year.
We look forward to sharing our strategy to unlock our longer-term full growth potential next week at our Investor Day.
Turning to Slide 17, as Rebecca mentioned at the start of the call from this quarter onwards we will exclude from adjusted net earnings, unrealized mark-to-market gains and losses on outstanding undesignated commodity hedges, until such time that the related exposure impacts operating results.
Our adjusted financial results and guidance reflect this change.
For the first quarter as we left 8% growth in the prior-year, organic net sales declined 4%, due to the anticipated cycling of year ago retailer inventory recovery and supply pressures.
The resulting year-over-year fall in [Phonetic] decline more than offset the favorable impact of net pricing in the quarter.
As Mark highlighted earlier consumer demand remains strong in [Technical Issues] basis were 5% higher, compared to two years ago or the first fiscal quarter of 2020.
Adjusted EBIT decreased 15%, compared to prior year, it was 1% higher on the two-year basis, despite the significant levels of inflation on ingredients, packaging, labor, warehousing and logistics.
Our adjusted EBIT margin was 17.4%, compared to 19.5% in the prior year and slightly down from fiscal 2020.
Adjusted earnings per share from continuing operations decreased $0.12 or 12% versus prior year to $0.89 per share, but remains well ahead of fiscal 2020.
On the next Slide, I'll break down our net sales performance for the first quarter.
As I mentioned, the impact of lapping the post-COVID search retailer inventory recovery and supply constraints largely related to industrywide labor challenges along with select material constraints, held back our ability to meet the continued elevated demand.
The operations team continue to execute well in a challenging environment.
Organic net sales decreased 4% during the quarter, driven by a 6 point volume headwind, which reflects lapping of the prior year retailer inventory recovery and the before mentioned supply constraints.
Favorable price and sales allowances drove a 4 point gain in the quarter, which was partially offset by a 2 point headwind due to some spend back on promotional spending in the quarter closer to pre-pandemic levels.
The impact of the sale of Plum subtracted 1 point.
All in our reported net sales declined 4% from the prior year.
Turning to Slide 19.
Our first quarter adjusted gross margin decreased by 200 basis points from 34.5% last year to 32.5% this year.
Mix had a negative impact of approximately 70 basis points on gross margin as we cycled last year's retail inventory recovery and favorable operating leverage.
Net price realization drove a 190 basis point improvement, due to the benefits of our recent pricing actions, partially offset by increased promotional spending.
Inflation and other factors had a negative impact of 470 basis points with the majority of the decline driven by cost inflation as overall input prices on a rate basis increased by approximately 6%.
Along with other industry participants, we experienced significant inflation across all input cost categories, including ingredients, packaging, labor, warehousing and logistics.
That said, our ongoing supply chain productivity program contributed 120 basis points to gross margin, partially offsetting these inflationary headwinds.
Our cost savings program, which is incremental to our ongoing supply chain productivity program added 30 basis points to our gross margin.
The previously described initiatives to mitigate inflation highlighted on the next page, include price increases and trade optimization, supply chain productivity improvements and cost saving initiatives and a continued focus on discretionary spending across the organization.
We remain focused on inflation mitigation as we continue to expect core inflation for the year to be high single-digits with a more pronounced impact in the second half of fiscal 2022.
As you saw on the previous page, the progress we made in the first quarter to mitigate these inflationary pressures reduced the impact to 130 basis points on our adjusted gross margin.
Moving to the next Slide.
We have achieved $15 million in incremental year-over-year savings and remain on track to deliver our cumulative savings target of $850 million by the end of fiscal year.
We are working toward expanding our plan to $1 billion and we'll share more details next week at our Investor Day.
Moving on to other operating items.
Marketing and selling expenses decreased $38 million or 18% in the quarter on a year-over-year basis.
This decrease was driven by lower advertising and consumer promotion expense or A&C and lower selling expenses.
Although, A&C declined 31% as investment was moderated to reflect supply pressure, we expect it to normalize as supply strengthened throughout the year.
Overall, our marketing and selling expenses represented 7.6% of net sales during the quarter and 130 basis point decrease, compared to last year.
Adjusted administrative expenses increased $17 million or 12% largely, due to expenses related to the settlement of certain legal claims as higher general administrative costs were largely offset by the benefits of cost savings initiatives.
Adjusted administrative expenses represented 6.9% of net sales [Technical Issues] to summarize the key drivers of performance this quarter.
As previously mentioned adjusted EBIT decline 15% as the net sales declined and the 200 basis points gross margin contraction, resulted in a $36 million and $44 million EBIT headwinds respectively, partially offsetting this was lower marketing and selling expenses, contributing 130 basis points to our adjusted EBIT margin.
This was a short-term action targeted in areas by supply constraints were most significant and we expect to fully return to targeted investment levels as soon as labor is in place and supply recovers.
Higher adjusted administrative and R&D expenses had a negative impact of 110 basis points and lower adjusted other income had a 30 basis point impact.
Overall, our adjusted EBIT margin decreased year-over-year by 210 basis points to 17.4%.
The following chart breaks down our adjusted earnings per share change between our operating performance and below the line items, a $0.17 impact of lower adjusted EBIT was partially offset by a $0.02 favorable impact from lower interest expense and a $0.04 impact of lower adjusted taxes, due to the favorable resolution of several tax matters in the quarter.
This resulted in better-than-expected adjusted earnings per share of $0.89, which was down $0.25 per share, compared to the prior year.
Turning to the segments, in Meals & Beverages organic net sales decreased 6%, as favorable price and sales allowances in the quarter were more than offset by volume declines across US retail products, including V8 beverages, Prego pasta sauces and US Soup, as well as in Canada.
Volume decreased primarily as a result of cycling the retailer inventory recovery in the prior year quarter and due to supply constraints, increased promotional spending relative to moderated levels in the prior year, partially offset the impact of recent price increases.
Sales of US Soup decreased 2%, cycling 21% increase in the prior year quarter.
Operating earnings for Meals & Beverages decreased 17% to $280 million, the decrease was primarily due to a lower gross margin and sales volume declines, partially offset by lower marketing selling expenses.
The lower gross margin resulted from higher cost inflation, higher levels of promotional spending, higher other supply chain costs and unfavorable product mix, partially offset by the benefits of recent pricing actions and supply chain productivity improvements.
Overall, within our Meals & Beverage division, the first quarter operating margin decreased year-over-year by 260 basis points to 22.1%.
Within Snacks, organic net sales decreased 1% to $1 billion, as favorable price and sales allowances were more than offset by volume declines and increased promotional spending, compared to moderated levels in the prior year quarter.
Declines in partner brands Pop Secret popcorn, driven by elevated prior year demand and Late July snacks due to supply pressures were partially offset by gains in Goldfish crackers and Pepperidge Farm cookies.
Sales of power brands increased 30%.
Operating earnings for Snacks decreased 5% for the quarter, driven by increased administrative expenses, due to the settlement of certain legal claims and a slightly lower gross margin, partially offset by lower marketing and selling expenses.
The slight decline in gross margin resulted from higher cost inflation, unfavorable product mix and higher level of promotional spending, largely offset by the benefits of recent pricing actions.
Supply chain productivity improvements and cost savings initiatives and lower other supply chain costs.
Overall within our Snacks division first quarter operating margin decreased year-over-year by 60 basis points to 13.2%.
I now turn to cash flow and liquidity.
Fiscal 2022 cash flow from operations increased from $180 million in the prior year to $288 million, primarily due to lower working capital related to outflows mostly from accounts payable and accrued liabilities, partially offset by lower cash earnings.
Our year-to-date cash outflows for investing activities were reflective of the cash outlay for capital expenditures of $69 million, which was comparable to prior year.
In light of the current operating environment, we are reducing our planned full-year capital expenditures from $330 million to approximately $300 million for fiscal 2022.
Our year-to-date cash outflows for financing activities were $220 million, the vast majority of which are $179 million, represented the return of capital to our shareholders, including a $160 million of dividends paid and $63 million of share repurchases during the quarter.
At the end of the first quarter we had approximately $475 million remaining under the current $500 million strategic share repurchase program.
We also have $250 million anti-dilutive share repurchase program, of which approximately $176 million is remain.
We ended the first quarter with cash and cash equivalents of $69 million.
Turning to Slide 28, as covered earlier, adjusted net earnings now excludes unrealized mark-to-market gains and losses on outstanding underestimated commodity hedges and the guidance for adjusted EBIT and adjusted earnings per share growth rates reflect this change.
We continue to expect full-year fiscal 2022 net sales, adjusted EBIT and adjusted earnings per share performance to be consistent with the guidance we provided during our fiscal year-end earnings call.
Overall, we expect accelerating inflationary pressures and higher labor-related costs to be partially mitigated with sustained in-market momentum, while at prior year results in the second quarter, we expect topline performance to improve sequentially year-over-year, as supply begins to recover.
However, with respect to margin, we expect continued pressure driven by additional core inflation across commodities and higher labor-related costs without the benefit of our second wave of pricing, which will not be in place until the end of the second quarter.
As we move into the second half of the year, we expect our inflation mitigation actions collectively along with the continuous recovery of labor to result in margin progress and earnings recovery through the year.
For the full-year, we expect organic net sales to be minus 1% to plus 1%.
Adjusted EBIT of minus 4.5% to minus 1.5% and adjusted earnings per share of minus 4% to flat versus the adjusted fiscal 2021 results.
The sale of Plum is estimated to have an impact of 1 percentage point of fiscal 2022 net sales.
I'm truly grateful for their continued dedication and commitment and look forward to sharing our strategy to unlock our full growth potential at our Investor Day next week.
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q1 adjusted earnings per share $0.89 from continuing operations excluding items.
q1 adjusted earnings per share $0.89.
reaffirms full-year guidance which has been adjusted.
qtrly net sales as reported (gaap) $2,236 million, down 4%.
qtrly organic net sales decreased 4% cycling retailer inventory recovery in prior year.
second quarter top-line performance is expected to sequentially improve year-over-year.
also in the second quarter, with respect to margin, the company expects continued pressure.
remains on track to deliver annualized savings of $850 million by end of fiscal 2022.
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