Lemonade's Q2 2024 Earnings Call: Impressive Growth and Strategic Shifts in the Insurance Industry

Lemonade (LMND) Q2 2024 Earnings Call Transcript | The Motley Fool

Hello and welcome everyone to the Lemonade Q2 2024 earnings call. My name is Maxine and I'll be coordinating the call today. [Operator instructions] I will now hand you over to Yael Wissner-Levy, VP, communications at Lemonade to begin. Yael, please go ahead when you are ready. Yael Wissner-Levy -- Vice President, Communications Good morning and welcome to Lemonade's second quarter 2024 earnings call. My name is Yael Wissner-Levy and I'm the VP communications at Lemonade. Joining me today to discuss our results are Daniel Schreiber, CEO and co-founder; Shai Wininger, president and co-founder; and Tim Bixby, our chief financial officer. A letter to shareholders covering the company's second quarter 2024 financial results is available on our investor relations website, investor.lemonade.com. Before we begin, I would like to remind you that management's remarks on this call may contain forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Actual results may differ materially from those indicated by these forward-looking statements as a result of various important factors, including those discussed in the Risk Factors section of our 2023 Form 10-Q filed with the SEC on May 1, 2024 and our other filings with the SEC. Any forward-looking statements made on this call represent our views only as of today and we undertake no obligation to update them. We will be referring to certain non-GAAP financial measures on today's call, such as adjusted EBITDA and adjusted gross profit which we believe may be important to investors to assess our operating performance. Reconciliations of these non-GAAP financial measures to the most direct comparable GAAP financial measures are included in our letter to shareholders. Our letter to shareholders also includes information about our key performance indicators, including customers, in-force premiums, premium per customer, annual dollar retention, gross earned premium, gross loss ratio, gross loss ratio ex CAT and net loss ratio. And the definition of each metric, why each is useful to investors and how we use each to monitor and manage our business. I'd also like to bring your attention to our upcoming investor day to be held on November 19, 2024 in New York City. We will be providing detailed updates on our strategic expansion plans, operating efficiencies and growth trajectory. Hope to see you there. With that, I'll turn the call over to Daniel for some opening remarks. Daniel? Daniel Schreiber -- Co-Founder and Chief Executive Officer Good morning and thank you for joining us to discuss Lemonade's results for Q2 2024. I'm happy to report continued consistent and strong progress across the board. Year-on-year, our top line grew 22%. Our adjusted EBITDA loss improved by 18% and our gross profit grew by a remarkable 155%. Despite a quarter that saw elevated CAT losses across the industry, our loss ratio came in at 79%, improving 15 points year-on-year. This is no accident. We have been laser-focused on reducing CAT volatility by growing products with lower CAT exposure, notably pet and renters, geographic diversification of growth, including via Europe where we recently launched homeowners insurance in the U.K. and France, continuing to sell Lemonade homeowners insurance in the U.S. only where our AI predicts attractive LTVs and simultaneously placing some home premiums with third parties in selected geographies. Tellingly, our trailing 12-month gross loss ratio continued its decline for the fourth consecutive quarter, also hitting 79%. We think this number in preference to the quarterly results neutralizes some of the volatility and provides a more bankable indication of our ongoing performance. But whatever your preferred metric is, the picture that emerges is the same. Great progress that enables us to deliver notably expanded gross margins. I'm also pleased to share that Q2 was net cash flow positive. We expect cash flow to be positive consistently here on out, excepting only Q4 this year where various timing issues will make that quarter a one-off exception. In any event, we don't expect our cash balances to decline by more than 1% or maybe 2% before climbing consistently. With these updates, we feel exceedingly well positioned to continue investing in robust and profitable growth. I also wanted to put a spotlight on our giveback program for a moment. A couple of weeks ago, we announced our contribution of more than $2 million to 43 nonprofits around the globe, our eighth consecutive year of giving back to dozens of local and global charities chosen by our customers. Social impact is a core pillar of who we are at Lemonade. Our contribution since inception now exceeds $10 million and this program reflects the collective power of the Lemonade community and its ability to drive meaningful change. It's something we're very proud of and we know this is only the beginning. Next, I'd like to hand over to Shai to tell you more about our recent efficiency improvements unlocked by our technology. Shai? Shai Wininger -- Co-Founder and President Thanks, Daniel. On the expense side, we've continued to deliver on our autonomous organization vision with remarkable stability. Our operating expense base, excluding growth spend which is now financed via the synthetic agents program, was unchanged year over year. This underscores the scalability of our tech vision which leads to measurable efficiency in our operations. This dynamic we're witnessing, robust predictable IFP growth alongside an expense base that remains comparatively steady and even shrinks at times, isn't a short-term anomaly. We expect this trend to persist in the coming quarters and years as we approach sustainable profitability at scale. This trajectory is a testament of the power of our technology-first approach and our commitment to operational excellence. Investors and analysts often ask about the practical impact of our investments in building our own tech-based insurance stack. I believe our recent quarterly results clearly demonstrate that. With large parts of our business running on code rather than people, I believe our tech obsession is paying off in a big way and helps separate us from incumbents in visible, measurable and impactful ways. What we've achieved so far is just the beginning. Our team has been hard at work on our next-generation technology platform, codename L2 which is designed to bring step-change improvements to areas such as underwriting, insurance operations, compliance and product development. With L2, we anticipate additional efficiency gains alongside acceleration of our product operations. These improvements should position us to adapt quickly to market changes, as well as capitalize on new opportunities, products, markets and even business models. The potential impact of L2 extends beyond mere cost savings. It's about reimagining how insurance companies should operate in the AI era. We look forward to sharing more about all this at our investor day, November 19 in New York City. And with that, let me hand it over to Tim to cover our financial results and outlook in greater detail. Tim? Tim Bixby -- Chief Financial Officer Great. Thanks, Shai. I'll review highlights of our Q2 results and provide our expectations for Q3 and the full year and then we'll take some questions. Overall, it was again a terrific quarter, with results very much in line with or better than expectations and continued notable loss ratio improvement across the board. In-force premium grew 22% to $839 million, while customer count increased by 14% to 2.2 million. Premium per customer increased 8% versus the prior year to $387, driven primarily by rate increases. Annual dollar retention or ADR was 88%, up 1 percentage point since this time last year. Gross earned premium in Q2 increased 22% as compared to the prior year to $200 million, in line with IFP growth. Our revenue in Q2 increased 17% from the prior year to $122 million. The growth in revenue was driven by the increase in gross earned premium, a slightly higher effective ceding commission rate under our quota share reinsurance, as well as a 45% increase in investment income. Our gross loss ratio was 79% for Q2 as compared to 94% in Q2 2023 and 79% in Q1 2024. The impact of CATs in Q2 was roughly 17 percentage points within the gross loss ratio, nearly all driven by convective storm and winter storm activity. Absent this total CAT impact, the underlying gross loss ratio ex-CAT was 62%, in line with the prior quarter and fully 10 percentage points better than the prior year. Prior period development had a roughly 3% favorable impact on gross loss ratio in the quarter. Notably, the CAT prior period development was about 2% unfavorable while non-CAT was about 5% favorable, netting out to the 3% favorable impact. Trailing 12 months, our TTM loss ratio, was about 79% or 12 points better year-on-year and four points better sequentially. From a product perspective, gross loss ratio improved notably for all products with year-on-year improvements ranging from 5% to 30%. Operating expenses, excluding loss and loss adjustment expense, increased 13% to $107 million in Q2 as compared to the prior year. The increase of $12 million year-on-year was driven predominantly by an increase in growth acquisition spending within sales and marketing expenses. Other insurance expense grew 25% in Q2 versus the prior year, in line with the growth of earned premium, primarily in support of our increased investment in rate filing capacity. Total sales and marketing expense increased by $12 million as noted or 48%, primarily due to the increased gross spend, partially offset by lower personnel-related costs driven by efficiency gains. Total gross spend in the quarter was about $26 million, roughly double the $13 million figure in the prior year. We continue to utilize our synthetic agents growth funding program and have financed 80% of our growth spend since the start of the year. As a reminder, you'll see 100% of our growth spend flows through the P&L as always, while the impact of the new growth mechanism of synthetic agents is visible on the cash flow statement and balance sheet. And the net financing to date under this agreement is about $44 million as of June 30. Technology development expense declined 12% year-on-year to $21 million due primarily to personnel cost efficiencies, while G&A expense also declined 3% as compared to the prior year to $30 million, primarily due to both lower personnel and insurance expenses. Personnel expense and headcount control continue to be a high priority. Total headcount is down about 9% as compared to the prior year at 1,211, while the top line IFP as noted grew about 22%. Including outsourced personnel expense which has been part of our strategy for several years, this expense improvement rate would be similar. Our net loss was a loss of $57 million in Q2 or $0.81 per share which is a 15% improvement as compared to the second quarter a year ago. Our adjusted EBITDA loss was a loss of $43 million in Q2, a roughly 18% improvement year-on-year. Our total cash, cash equivalents and investments ended the quarter at approximately $931 million, up $4 million versus the prior quarter, showing a nice positive net cash flow trend in the quarter. This positive net cash flow contrasts markedly with a net use of cash of $51 million in the same quarter in the prior year. With these metrics in mind, I'll outline our specific financial expectations for the third quarter and full year 2024. Our expectations for the full year remain unchanged as compared to our guidance on our Q1 earnings call. As has been the case in some prior years, there's a notable seasonal difference in our expected results in Q3 and Q4. Specifically, Q3 is typically our highest growth spend quarter which tends to drive up sales and marketing spend and also, typically a higher expected loss ratio as compared to Q4. Our third quarter guidance and our implied Q4 guidance reflect these seasonal themes. From a gross spend perspective, we expect to invest roughly $25 million more in Q3 as compared to Q3 in the prior year to generate profitable customers with a healthy lifetime value. At the same time, we will be proactively nonrenewing customers with unhealthy lifetime value, specifically certain CAT-exposed homeowners policies. As our AIs have become increasingly good at identifying such policies and as our latest underwriting rules have been approved by regulators, we now have the ability to identify older policies that we wouldn't write today. We expect this to remove between $20 million and $25 million of IFP from our book in the second half of 2024, dampening growth in the immediate term while concurrently boosting cash flow and profitability in the medium term and further reducing CAT volatility. Importantly, though, our IFP guidance for the year reflects these plans and remains unchanged. For the third quarter of 2024, we expect in-force premium at September 30 of between $875 million and $879 million, gross earned premium between $208 million and $210 million, revenue between $124 million and $126 million and an adjusted EBITDA loss of between $58 million and $56 million. We expect stock-based compensation expense of approximately $16 million, capital expenditures approximately $3 million and a weighted average share count for the quarter of approximately 71 million shares. And for the full year of 2024, we expect in-force premium at December 31 of between $940 million and $944 million, gross earned premium between $818 million and $822 million, revenue between $511 million and $515 million and adjusted EBITDA loss of between $155 million and $151 million. And we expect stock-based compensation for the full year of approximately $64 million, capex of approximately $10 million and a weighted average share count of approximately 71 million shares. And with that, I'd like to hand things back over to Shai to answer some questions from a few of our retail investors. Thanks, Tim. We now turn it over to our shareholders' questions submitted through the safe platform. I'll start with Matthew H. who asks, how are we leveraging AI technology to improve underwriting, claim processing and overall customer experience? And are there any major business risks or challenges to further leveraging AI? Thanks, Matthew. We've spoken about this at some depth in prior shareholders' letters. As I shared in the past, we're well underway to leverage AI at every stage of the customer journey, as well as in many areas of our internal operations. We do that to drive efficiency, improve our underwriting and enhance customer experience with fast and always available smart service. Our underwriting, customer service and claims management, even employee management, administration, engineering, product operations, all use AI heavily. As an example, in just over a year, we went from a standing start to having a comprehensively rolled out generative AI platform to handle incoming customer communications. We handle email and text communications coming in and we're now handling more than 30% of these interactions with absolutely no human intervention. Progress to date is the tip of the iceberg though and I expect us to continue to focus on additional applications of these technologies, delivering concrete measurable impact to the business and helping us widen the gap between our tech and the competition's. Nomi K. asks if we can share the performance metrics and customer feedback from states where all five of Lemonade's insurance products are available and what are the main challenges or limiting factors preventing a broader rollout to additional states and how do we plan to address these? Thank you, Nomi. The specific order of state expansion is generally based on growth potential and expected profitability in those markets, as well as prioritization aspects that have to do with focus and resource allocation. We expect cross-selling activity to be an increasingly powerful driver of growth as a result. In Illinois, for example, where we have all of our products available, we're seeing multiline customer rates that are roughly double the rest of the book. We also see other metrics improve, such as superior retention rates after bundling and outstanding customer feedback as measured by NPS. There were several questions about car rollout timing and expectations. And I'll just say that the organization is running around car in a remarkable way and we're expecting the growth rate of car to begin accelerating in the near future as a result. We plan to roll out car several additional states during 2025, with our main considerations being profitability predictions and regulatory approval rates. We aim to operate first in states where we can move quickly and write new business profitably. In the second half and beyond with the unlock of rate adequacy in multiple geographies, we'll be expanding investment in new customer acquisition, as well as cross-selling to our existing user base. And now I'll turn the call back to the operator for more questions from our friends from the Street. Operator [Operator instructions] Our first question today comes from Jack Matten from BMO. Please go ahead, Jack. Your line is now open. Jack Matten -- BMO Capital Markets -- Analyst Hey. Good morning. Just wondering if you could provide some more details on the non-renewals of the CAT-exposed home business. In which states are your actions primarily taking place? And are there particular years of business that you're focused on? I guess in general, if you can talk about any insights that you've learned from your more recent models that led to your decision. Daniel Schreiber -- Co-Founder and Chief Executive Officer Yes. A couple of thoughts there. In terms of the distribution across states, it's really more of a -- it can be concentrated in states. It's really focused -- tends to be focused more on expected lifetime value which tends to be quite driven by a higher than target loss ratio that tends to be concentrated within the home book almost entirely which is the most challenging loss ratio we have. We've talked a little bit about in the letter the range that we're targeting which is 20 to 25. We talk about a range because it's not a hard number but it's based on what we know and as we're kind of developing that analysis, that feels like the most appropriate range. Important to note that while it puts downward pressure on IFP growth, as all of our -- every customer kind of adds up to that total IFP number, from a cash perspective or a value perspective, it's got a very high ROI. We're taking out much more expected cost than we are taking out contribution from the premium, so it's definitely ROI positive. If you take out, for example, $25 million of IFP with an elevated loss ratio, you can generate, using our own model, something like $50 million or $60 million in net positive value. A little short-term pressure on IFP but over the medium term, long-term value. In terms of timeframe, these tend to be older policies, so our underwriting rules and our AI models get a little bit better every day and so the concentration tends to be business we wrote two or three or four years ago in some cases. And as noted, the vast majority, if not 100% of this business, would be business we wouldn't write today under our current underwriting guidelines. Jack Matten -- BMO Capital Markets -- Analyst That's helpful. Thank you. The second question is on capital. Can you talk about the premium to surplus ratio that Lemonade expects to maintain as your business mix evolves? And I guess somewhat relatedly, it looks like your invested asset balance has been falling in recent quarters. Is that something that the company expects to continue doing moving forward? I think just trying to get some insights into that investment income. Thank you. Tim Bixby -- Chief Financial Officer Sure. On the capital surplus, we've not talked about that for a while because things are essentially unchanged. Our target is and continues to be a roughly 1:6 ratio of acquired surplus to gross earned premium. And we've got at least a couple of very effective tools in place to help us drive that number to what is arguably sort of best-in-class in the industry. This is what many insurance companies shoot to do. And I think we're performing quite well on that metric. Our quota share structure, our Cayman captive structure, these are really designed not only to mitigate volatility but more importantly to drive -- to enable significant capital surplus efficiency. That's really unchanged at that 1:6 ratio. From a cash investment standpoint, yes, you will note if you kind of charted out the cash balances has increased somewhat as a percentage of the total. That's not so much a concerted strategy. I would expect that trend to moderate or even flatten out before too long. However, the interest rate environment is what it is. We're expecting what you and others are expecting in the market, that there will be perhaps more downward pressure on interest rates than upward pressure and we factored in sort of the most current forecasts into our guidance in terms of what the expected investment income is likely to be. The good news is, our cash investments balance actually went up this quarter in total. We're earning really strong returns on the cash, as well as the investments. And so, that's something that I would highlight. We foresee that cash and investments balance basically troughing, might drop another 1% or 2% as we noted but that puts us well above a $900 million total cash investments balance from here on out as far as we can see. Compare that to three or four years ago when there was quite a bit more uncertainty as to our growth trajectory and where that balance might end up, that's a dramatic change and I think it probably has a tremendous foundation for us going forward. Thank you. The next question comes from Michael Phillips from Oppenheimer. Please go ahead, Michael. Your line is now open. Michael Phillips -- Oppenheimer and Company -- Analyst Thank you. Good morning, everybody. A question first on auto and kind of follow-up from the opening comments about new state expansion as you get into next year. The last 10 I had, I think you were in 11 states. I'm not sure that's still right. As you look out over the next maybe 18 months, given kind of the decent rate environment for auto, it might be slowing down. But should we expect state expansion by say yearend '25 to being close to like 20 states or 40 states or just kind of how aggressively you want to be over the next 18 months? Daniel Schreiber -- Co-Founder and Chief Executive Officer No, I don't think we'll be at 40 states. And of course, to state the obvious, not all states are born equal. We will be expanding throughout 2025. We haven't given specific numbers and so my answer today is going to remain a little bit vague still. One of the driving factors is going to be the graduation of renters to be car customers. We will be looking and one of the guiding principles Shai spoke about, regulatory environment and some predictive loss ratios. Another one is where we have the largest footprint of renters who have cars but don't have car insurance with us and that will be another driving force. But we're not ready to disclose numbers of states yet. Michael Phillips -- Oppenheimer and Company -- Analyst OK, I can appreciate that. Thanks, Daniel. I guess continuing with that, maybe a follow-up on that is, typically, as we're growing in new states, there can be some pressure on our margins in auto. Maybe for you guys, I guess I want to see what -- do you think that might be a bit muted than what normally is the case, given -- I think you've talked about knowledge that you have from your current renters and homeowners customer base and how that can translate into more information in your initial pricing for auto as that starts to grow? Daniel Schreiber -- Co-Founder and Chief Executive Officer Yes. Look, we are -- I sort of mentioned this before but we are very bullish in the medium to long term on car. We think it's a highly differentiated product with a strong and structural competitive advantage given that at first approximation, all our customers use telematics on an ongoing basis. And whereas at first approximation for the incumbent that's none or zero. This is really a very powerful differentiator quite beside or in addition to the fact that we have really spectacular user experience, very high customer satisfaction levels, etc. Going back to my comment earlier about the renters aspect here, yes, we are seeing that renters who buy car insurance have a much, to use your words, muted loss ratio, In fact, their whole economics are dramatically different. The cost of acquisition is effectively zero. You might even conceive a bit as being negative cap because our renters book is very profitable. And then, you've got existing customers who ostensibly have paid to be Lemonade customers but they are profitable at the outset and then we get to sell them a car policy with no incremental cost. Again, I'm rounding here but I think a price approximation that holds true. And we have found them to be not only highly profitable because of the absence of any customer acquisition cost but much better because we do use the factors that you said, much better risks. We can price them effectively. We don't see the new business penalty that you see when you usually grow a book. So very, very different unit economics and lifetime value of existing customers. This is really, I think, a strategic pillar that we will expand on during our investor day as well later in the year. We do have over 2 million existing customers, many of whom have car insurance, just not with Lemonade. And that opportunity translates into a very, very sizable and ultimately we expect, very profitable opportunity for us. Shai Wininger -- Co-Founder and President Probably also worth noting that the external environment is improving as well. For some time, we and other car providers were chasing a target with inflation's unfavorable impact on cost of repairs and cost of claims. The data is now really showing that that trend has slowed, if not stalled and in some cases may even reverse. And so, chasing that target is now much -- the impact of our rate increases, both those already in place and those we are continuing to work on, have an even greater impact and that really provides a higher level of confidence comfort in our planning for car for the rest of this year and well into next year as well. We noted that our gross loss ratio improvement across our product lines improved anywhere from 5% to 30%. Car was right at the upper end of that range, so we're seeing lots of great indicators. Thank you. The next question comes from Tommy McJoynt from Stifel. Please go ahead. Your line is now open. Tommy McJoynt -- Stifel Financial Corp. -- Analyst Hey. Good morning, guys. Thanks for taking my questions. Tim, kind of going back to the first question that you got on the nonrenewal side, you mentioned the $25 million of non-renewed IFP and that's going to be offset by it sounded like I think you said $50 million to $60 million of sort of net positive value. Let's call it $50 million. Sorry, is that saying that the LTV of those policies, instead of being presumably positive when you wrote it, is now being sort of reassessed at negative $50 million? And hence, by not writing, non-renewing that business, it will now be zero? Just kind of help explain sort of what that $50 million to $60 million number that you mentioned actually is. Tim Bixby -- Chief Financial Officer Yes. In rough strokes, the way you described it is right. If a customer has an expected lifetime value let's say of three times its acquisition cost which is often typical for us, that means over the course of their lifetime, two, three, four years depending on the product or more, we expect to generate that incremental cash flow or value. What this says is we expect that lifetime value to be a negative $50 million or $60 million in the case I described for an IF, so think of that ratio as sort of a negative 2:1 ratio. I mean, it's really almost entirely driven by the elevated loss ratio. If a customer has an expected 150% loss ratio for example and you carry that customer out for a couple three years or more, that's the driver. I think you have the analysis right, it's rough justice but it's notable -- notably positive ROI for those changes. Tommy McJoynt -- Stifel Financial Corp. -- Analyst OK. Got it. And do you know what the impact on the loss ratio from that sort of $25 million in IFP was in the first half of the year? Or even in absolute dollars, kind of how much sort of operating loss that business generated, contributed? Tim Bixby -- Chief Financial Officer Hard to really put a precise number on that. I would think of that range of $20 million to $25 million is over the course of the year, the vast majority in Q3 and Q4. It's really a forward-looking number and expected impact. We have started the process. There was a nominal amount in Q2 but I would say it probably rounds to pretty close to zero. It's really a Q3, Q4 and forward expectation, a little more concentrated in Q3 than Q4. Our loss ratio does -- has borne the burden of that business and so it's really notable I think that our loss ratio improved mid-double digits year-on-year with some of that downward pressure. And so, all of these changes, not just rate changes, will have a favorable -- continued favorable impact on the loss ratio going forward. Daniel Schreiber -- Co-Founder and Chief Executive Officer And Tommy, maybe I'll just add -- sorry, just one other kind of vantage point of color and Tim mentioned this briefly in his comments, this is really a homeowners focused fix. It's the one part of our business that has had pockets of sustained negative LTV. And in addition to being negative in LTV, there have also been an environment that oftentimes we could not get the rate approval. In theory, any risk can be priced adequately but we don't always find regulators affording us that luxury. This is part of the business where we just were not able to get the approvals and don't expect to in any fashion. Otherwise, we would have been kind of shown more forbearance if we thought it was on the cusp of turning profitable. But in addition to being stubbornly unprofitable, it also tends to concentrate very much in volatile parts of the country. Even some of this business were we to get to long-term average profitability, we've always sought to avoid the most CAT-exposed part of our business -- of the country rather, sorry and we have avoided writing in the most CAT exposed places really since our inception in places where we have still found that the volatility is higher than we want now, knowing what we know. We're also taking this opportunity to non-renew that part of the business. Tim Bixby -- Chief Financial Officer And maybe just to put a fine point on it based on a couple of questions I've gotten already, I'll answer a question that has not been asked which is, if this number is 25 as we expect it to be, the question might be, would your IFP expectations have been $25 million greater if not for the impact of this? The answer is yes. Yes. Tommy McJoynt -- Stifel Financial Corp. -- Analyst OK, got it. Appreciate that color. And then, just quickly, you mentioned the expectations for growth spend in 3Q to be $25 million up year over year. Did you give a 4Q number? Or do we have the full year kind of expectation? Tim Bixby -- Chief Financial Officer Yes. I would think of the full year as really unchanged. The timing over the course of the quarters has changed somewhat. The guidance we gave historically is sort of between $100 and $110 million, $105 million is the number we've mentioned. I think we're still sort of on track and planning to spend that rough amount over the course of the full year. We have adjusted the timing of that somewhat a little bit more than initially planned in Q3 than otherwise. Q3 is typically the highest gross spend quarter in any case in most years. And the fourth quarter, obviously, if you kind of do the math, will be somewhat elevated as well. Q1 was really the ramp-up quarter and so it's a pretty steep climb and we expect Q3 to be at the rate we disclosed. Thank you. The next question comes from Bob Huang from Morgan Stanley. Please go ahead, Bob. Your line is now open. Bob Huang -- Morgan Stanley -- Analyst Great. Thank you. First one is on your 17 points of improvement in CAT losses which was -- I mean, sorry, 17 points of the impact on CAT losses which is a five-point improvement. Directionally speaking, that's obviously similar to the industry. As you non-renew the homeowner side, is there a run rate expectation on what CAT losses should look like going forward? Can you give us a little bit more color on just like how we should think about that impact? I know that you already talked about quite a bit on the impact on the other side of things on the homeowner renewal. Just to see if there's any additional color on the CAT side. Tim Bixby -- Chief Financial Officer That's probably a little bit beyond some of the guidance we've given. I can give a little bit of the way you might think about it. Our home business as a share of the total business is coming down as a percentage but just modestly. I think it came in the quarter and this is home and condo combined, came in about just under 20% and it's down a couple of points year-on-year. And so, you can kind of back into -- if we were to take $25 million of IFP out, back into what that impact might be. In terms of the specific reduction on loss ratio, it's a little tricky to do that. I'm not going to venture that far. But CAT is really isolated almost entirely to home, not quite 100% but primarily home. And really, these are the most challenging policies obviously that we'll go after. I'll leave it to you to kind of do some math but that's how I would go about it. Bob Huang -- Morgan Stanley -- Analyst OK. Maybe second one on just how we should think about ceding commission. If we look at a ceding commission as a percent of premium last call it five quarters, it's generally about 20%. This quarter was notably lower than that. Is this more of a one-time thing? What's driving that? And should it go back to about 20% of premium going forward? Tim Bixby -- Chief Financial Officer Yes. A couple of ways to think about the ceding commission. Year-on-year there is a change because there was a change in the structure. The prior year was a fixed structure up through our July renewal a year ago and so you saw in the face of the P&L roughly a 20% effective commission. Now, our commission, because of the way we do the accounting, it's split into two pieces, so our effective commission rate was about -- running about 23%. But the most important thing was it was static. It was a fixed number. That's now variable. That's helpful in some ways but a little less -- a little trickier when you're building a model. But the net difference over -- I think one way to think about it is to look at Q1 and Q2, the net commission was about 18% versus 20%, so modestly lower but just by a couple of points. But more volatility, more variability, so Q1 was a fair bit lower, Q2 was higher. We'll continue to see that move around a little bit quarter-to-quarter but that gets trued up as you go through the course of the year. I would expect -- we'll give as much of an indication on that as we can but I would think of it as a couple of points lower than prior year but there are some offsets to that as well. Our renewal this year was similar. It is also a sliding scale that begins this month, began in July. But the scale and the expected effective rate will actually be a little bit better. At this point, it's hard to say if it gets back to the prior level but it should be up maybe one point or two on any sort of apples-to-apples comparison so slightly better terms in this renewal. Probably also -- probably also worth answering another -- I like answering questions that weren't asked, so I'll throw in another one which is, because a loss ratio varies obviously quarter-to-quarter, the typical pattern has been a Q4 loss ratio that's the lowest of the four quarters. That's happened often in prior years. We expect it will happen this year. And if that plays out as expected, that has a pretty strong favorable impact on that commission rate. And so, again, a little more volatile quarter-to-quarter but if things play out as expected and as historical patterns, you'd see a nice favorable impact over the course of the year. It gets us back on track versus some of the prior quarters. It can be a little bit lower commission rate. Operator Thank you. The next question comes from Matthew O'Neill from FT Partners. Please go ahead, Matthew. Your line is now open. Matthew O'Neill -- Financial Technology Partners -- Analyst Thank you so much for taking my question. I just wanted to ask a little bit about premium per customer. It's been growing impressively but the rate may be decelerating slightly. I was just curious if you could give us an assessment of kind of how far through the rate increases you are on the in-force book? Tim Bixby -- Chief Financial Officer Yes. That can vary quarter-to-quarter. It has been a pretty steady contributor but our customer count was a stronger contributor to growth this year quarter-on-quarter than the price increase. It varies by product. As I mentioned in car, you're seeing a pretty dramatic impact in rent, much less so because it's really so optimized. The loss ratio is such a strong loss ratio as it is and pricing is quite good. So it varies by product. In terms of where we are, I think two or three quarters ago we mentioned that we were sort of halfway through. There's $100 million or so remaining to earn in. That's more or less unchanged because as we -- the pace of us earning in rate and the pace of us filing for new rates has been roughly in balance. I think of us in a similar spot now where there's still plenty of rate to earn in. Obviously, that doesn't last forever. There will always be rate filings and always increases even in a low or no inflation environment but we're quite a ways away from that. That is factored into our -- the Q3, Q4 guidance that we'll continue to earn at that pace and it will go into next year. Things that are approved and in place will earn well into next year. Matthew O'Neill -- Financial Technology Partners -- Analyst Thanks. That's very helpful. And maybe just a quick one and I realize I may be jumping the gun on potential investor day content but I know you've spoken about the long-term or ultimate target for the loss ratio in the high 60s to 70s. I don't know if there's kind of an internal or a way to think about the ultimate target for the expense ratio going forward. Daniel Schreiber -- Co-Founder and Chief Executive Officer We are determined to have an expense load that will be absolutely better than the industry. We're beginning to look less at ratios because we also intend to be a price leader. And that might not give you as clear a picture of just how advantaged we think we're becoming due to our technology but it will reflect itself in I think best-in-class expense ratio and even more dramatically in actual expense load. If you kind of put it on an apples-to-apples basis with the same premium and that's being charged by competitors, it will manifest itself more powerfully still than when you look at it against our own lower premiums because we think we get to pass some of those savings on to our customers and that can accelerate growth, accelerate retention, lower cost of acquisition and allow us to achieve our ultimate and rather ambitious goals for the company. But if I answer your question kind of more straightforwardly, we think that at scale, we will be in the teens. We disclosed last quarter that the LAE component of our expense stack has already achieved parity with the very best in the industry. We reported a 7.6% LAE last quarter. Shai mentioned some of the efficiencies that we're gaining through automation and we're really seeing these rollout very, very powerfully in some of the numbers that we shared earlier about what's happened to our headcount expense, what's happened to our what we're calling IFP per human, how many people were needed to gen -- as we've doubled our book, we've been able to over the course of the last few years, we've been able to halve the ratio of people needed to generate every dollar of premium. We're seeing very dramatic advancements, all of which will ultimately reflect themselves in our competitive expense structure, some of which will manifest as lower prices and some of which will manifest we believe still as best-in-class expense ratio. That said, I'll add to that and there was reference to this in the letter as well, we think of for structural reasons that may be obvious and some that are less than obvious, we think of growth as the gift that keeps on giving. We really think that the number that I just gave and the direction that I just outlined will become -- at the moment, you can look at various numbers in the field in action and I referenced a few of them. I think a few years from now, it will be unmissable. It will be kind of glaringly obvious and the difference between now and then is that will continue to grow. And as we continue to grow, as we've doubled our business while holding our expense structure flat, we kind of shared that over the course of the last few years, we've seen expense net of customer acquisition actually decline even as we've enjoyed record growth. Clearly, that moving forward, holding expenses relatively flat and really start seeing how this generates a very, very profitable business. But that dynamic will continue to manifest with ever greater force as we continue to grow. When we double our business, you will see it with greater clarity. When we 10x our business, as I say, it will be glaringly obvious. Matthew O'Neill -- Financial Technology Partners -- Analyst Thank you for that detailed answer, really helpful. I'll jump back in the queue. Operator Thank you. The next question comes from Yaron Kinar from Jefferies. Please go ahead. Your line is now open. Unknown speaker -- -- Analyst Hi, guys. Good morning. This is Charlie on for Yaron. A couple of questions. The first one, with the decision to non-renew certain CAT-exposed homeowners, was that previously contemplated in guidance? OK. Thanks. And then, are you guys able to give us CAT prior year development and LAE on a net basis? Tim Bixby -- Chief Financial Officer The prior period development, you can split into two pieces. It was three points favorable. It was two points unfavorable from a CAT perspective and five points favorable from a non-CAT perspective. Netting out to the three favorable. Unknown speaker -- -- Analyst OK. Sorry. And just to clarify, was that gross CAT or net CAT impact? Yes. And then, that breakdown would be roughly similar on a net basis, the prior period development. The total CAT impact on a net basis was about 15 points, whereas on a gross basis, it was about 17 points. LAE came in about 8%. It's been 7-point, mid-7s, edged up a little bit but in that sort of 7% to 8% range, by 8% this quarter. Unknown speaker -- -- Analyst OK, great. And then, last one if I could, just looking at the underlying loss ratio, it looks like contemplating those components, you guys saw about 22 points of underlying improvement. But if we look at the first quarter of 24% on a year-over-year basis from first quarter of '23, it looks like it was relatively flat. Is there anything underlying that that you guys could provide some color on? Tim Bixby -- Chief Financial Officer Pretty distinct quarters. Yes, on a full quarter basis, it was pretty stable. I think that it's really important to look at the year-on-year comparison from a seasonal perspective. And on a trailing 12 months basis obviously continued significant improvement. Any given comparison of quarters, you might see some trends that are interesting but not necessarily indicative of a longer-term trend. Nothing in particular to call out that was distinct between Q1 and Q2. Q2 was a really interesting quarter as it evolved, really significant impacts early in the quarter and really dramatic favorable outcomes by the end of the quarter, netting out to what ended up to be a quarter that was even better, just modestly better than our expectations. The months can be pretty unpredictable but the quarters are a little more predictable. [Operator instructions] We have a follow-up question from Bob Huang from Morgan Stanley. Please go ahead, Bob. Your line is now open. Bob Huang -- Morgan Stanley -- Analyst Hi. Thanks for this. Maybe just a follow-up on the PYD question. Five points of favorable on everything else and two points unfavorable on the CAT PYD. On the five points, can you give us maybe a little bit more color on the geography of those? Like what are those five points coming from if possible? Sorry if I missed this a little earlier. Daniel Schreiber -- Co-Founder and Chief Executive Officer We did not. It's a little more concentrated in the pet product but it was distributed across products other than home. The CATs are primarily a home dynamic and the increase was driven by those really significant storms from a year ago and a bit earlier this year that have evolved, continue to evolve. But the underlying favorable development I think is really testament to the non-CAT portion of the business which is really all the product lines other than home. Bob Huang -- Morgan Stanley -- Analyst OK. Basically, CAT was unfavorable and dogs were favorable. Thank you for that that's very helpful. On the other one, maybe on the LTV to CAC side. I know that you talked about previously, you kind of mentioned LTV to CAC is about three times, then that would be the ratio. And then, I think one thing we're trying to figure out is that if you have these homeowner non-renewals, going forward, does that three times LTV to CAC equation still holds? How should we think about that renewal impact on the LTV to CAC? Tim Bixby -- Chief Financial Officer Yes. LTV to CAC is an important metric but it's a forward metric. It's based on a model. It's based on all the information we collect. it improves a little bit every day, every week, every month as we go forward. When we acquired that business, when our models were by definition less sophisticated than today, two, three, four years ago, we expected those to be profitable customers. As we learn more in our models and our existing customer base and claims activity, invariably a certain portion of the customer base, their expected LTV will change. For newly acquired customers, there is no change, so we expect customers we acquire today and tomorrow to be fully profitable. We've seen a ratio greater than 3:1. 3:1 is a good rule of thumb but we've seen certainly periods where it's three and a half or four or more. There tends to be a little bit more pressure when you spend more. We're spending double today what we spent a year ago and that tends to put downward pressure on LTV to CAC but that's a good thing. And we earn our way in and we develop channels, we expand our spending. And overall, 3:1 is a good metric to think about. I'll add one other comment in that area which I think is helpful which is LTV to CAC is kind of policy by policy focused. And if you look at our spending per net added customer, you might think things got more expensive for us in the quarter. And while that exact math is correct, it's important to look at IFP. Net added IFP, gross added IFP really is what we're acquiring with that tax spend. And by that measure, we were actually more efficient in the second quarter than we were in the year-ago quarter and even in the prior quarter. All around, that number is stable and that's what's enabling us to really say we're very comfortable with growth rates that are accelerating. You started out the year in the low 20s, going into the mid-20s and now we're pushing toward the high 20s growth rate and that's a core driver for them. Daniel Schreiber -- Co-Founder and Chief Executive Officer Maybe I'll talk about a comment of color commentary, Bob, as well. LTV to CAC, you always want it to be as high as possible per customer. But truly, you want to keep growing it until you hit the marginal customer where the LTV equals CAC. In other words, if you could spend $1 and get $1.10 instead of getting $3, that is still marginally good for the business, you're still growing profitable business. And since our LTV calculations take onboard the time value of money that's already factored in at a fairly robust discount rate. While LTV to CAC is three, that's our average, we have many higher customers than that. We acquired many customers in the double digits of LTV to CAC as well. When we'll stop investing is when we hit the marginal customer who's closer to an LTV to CAC of one. We take a bit of a margin of safety but conceptually, that is the philosophy. We want every marginally profitable customer, we want them and we will continue to grow using that. We have never deviated from that. We have never tried to acquire customers of a negative LTV. Sometimes, we find this confusing to some investors because in the short term, they do customer acquisition can impact our financials negatively in the short term. The year in which you spend that CAC, because we are not an agent-based business and we pay all -- we take all our pain upfront, we earn it back over time. Therefore, when we grow, sometimes it can appear to be a near-term loss but that is just the nature of the flow of time. Fundamentally, it's about spending $1 now and getting $3 back in today's terms. And if that means that in the near term, we take a hit to our EBITDA, we're OK with that. We don't take a hit to our cash because we've got a synthetic agent program in place, so we've neutralized the trough in terms of the cash, in terms of EBITDA. Those things will work their way out during the course of the lifetime of the customer. At any rate, because of that, we have always sought to grow customers on an LTV to CAC basis, never acquiring knowingly negative LTV business. Over the course of the last couple of years with inflationary pressures and others, larger swaths of the nation and of our portfolio were hard to grow in an LTV positive environment and we've spoken about that and we slowed our growth which we're now reaccelerating. And much of those segments of our business have become profitable over time as we got to adequacy and we've spoken about this, we were able to recover them back to where we thought they would be all along. What we're talking about today for the first time is that in addition to being conservative and careful and never knowingly writing negative business and proactively working to bring back into profitability any business that fell out of it and largely succeeding, we're also not tolerating business that has fallen between the cracks and we've not been able to bring back to profitability. Not only are we not writing knowingly unprofitable business, as we never have, we are now not renewing such business either, having in some places, exhausted in the near term what rate can deliver. And therefore, the philosophy is the same philosophy, the profitability focus of the business has been the same consistently. But now actually not really slowing down in places that aren't profitable but even potentially going into reverse markets that don't contribute. And Tim's earlier comment that, yes, you may see a hit, a potential hit of $25 million to IFP, we're reiterated guidance. We think we're going to manage that within the guidance already given. We think that we're overdelivering for the year and we have that spare to be able to hit guidance notwithstanding this. You won't see a hit to the IFP but it could have been much higher, as Tim said. But we've always been focused not mainly on growing IFP but in growing the total value of the book and this really as a boon to that, as Tim said, $50 million, $60 million of LTV added to our business because of this decision.

Earnings call: Lemonade reports a remarkable 155% growth in gross profit By Investing.com

Lemonade Inc. (LMND), the tech-first insurance company, has reported a robust second quarter for the fiscal year 2024, with significant growth in key financial metrics. The company has demonstrated a 22% increase in top-line growth and a remarkable 155% growth in gross profit. Lemonade's adjusted EBITDA loss improved by 18%, and the company's gross loss ratio also showed improvement, reaching 79%. The insurer's strategic moves to reduce catastrophe (CAT) exposure and invest in technology have paid off, leading to stable operating expenses and enhanced efficiency. Lemonade's focus on its next-generation technology platform, L2, and its giveback program, contributing over $2 million to nonprofits, highlights its commitment to growth and social responsibility. Despite plans to nonrenew certain CAT-exposed policies, Lemonade maintains unchanged expectations for Q3 and the full year 2024, with a focus on growth spend and reducing CAT volatility. Key Takeaways Company Outlook Bearish Highlights Bullish Highlights Misses Q&A highlights Lemonade's second quarter earnings call showcased the company's resilience and strategic focus on reducing volatility and enhancing profitability. With a strong emphasis on technological innovation and customer acquisition, Lemonade is poised to continue its growth trajectory while navigating challenges in the insurance market. The company's unwavering commitment to its giveback program and upcoming tech platform L2 indicate a forward-thinking approach that aligns with its financial goals and social impact objectives. Lemonade's investors and customers can look forward to its expansion into new markets and continued efforts to optimize its insurance offerings. InvestingPro Insights Lemonade Inc. (LMND) has been navigating through a transformative phase, as evidenced by the latest financial data and market performance. With a market capitalization of $1.27 billion and a notable revenue growth of 47.5% in the last twelve months as of Q1 2024, Lemonade's strategic initiatives are starting to reflect in its financials. InvestingPro Tips highlight that while analysts are cautious about the company's profitability in the near term, Lemonade's stock has experienced strong returns, with a 37.15% increase over the last month and a 43.05% uptick over the last six months. This suggests that investors are responding positively to the company's growth prospects and operational improvements. Additionally, Lemonade's liquid assets are currently sufficient to cover short-term obligations, which is an encouraging sign of financial stability. This is particularly relevant as the company focuses on growth spend and reducing CAT volatility, as mentioned in the article. InvestingPro Data further reveals that despite a negative P/E ratio of -6.27, indicating that the company is not currently profitable, the strong revenue growth and gross profit margin of 37.69% for the last twelve months as of Q1 2024 underscore Lemonade's ability to generate income relative to its sales. Investors seeking more in-depth analysis can find additional InvestingPro Tips for Lemonade at https://www.investing.com/pro/LMND, which includes a total of 8 tips to help gauge the company's performance and potential investment opportunities. Full transcript - Lemonade Inc (LMND) Q2 2024: Operator: Hello and welcome everyone to the Lemonade Q2 2024 Earnings Call. My name is Maxine [ph] and I'll be coordinating the call today. [Operator Instructions] I will now hand you over to Yael Wissner-Levy, VP, Communications at Lemonade to begin. Yael, please go ahead when you are ready. Yael Wissner-Levy: Good morning and welcome to Lemonade's second quarter 2024 earnings call. My name is Yael Wissner-Levy and I'm the VP Communications at Lemonade. Joining me today to discuss our results are Daniel Schreiber, CEO and Co-Founder; Shai Wininger, President and Co-Founder; and Tim Bixby, our Chief Financial Officer. A letter to shareholders covering the company's second quarter 2024 financial results is available on our Investor Relations website, investor.lemonade.com. Before we begin, I would like to remind you that management's remarks on this call may contain forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Actual results may differ materially from those indicated by these forward-looking statements as a result of various important factors, including those discussed in the Risk Factors section of our 2023 Form 10-Q filed with the SEC on May 1, 2024 and our other filings with the SEC. Any forward-looking statements made on this call represent our views only as of today and we undertake no obligation to update them. We will be referring to certain non-GAAP financial measures on today's call, such as adjusted EBITDA and adjusted gross profit which we believe may be important to investors to assess our operating performance. Reconciliations of these non-GAAP financial measures to the most direct comparable GAAP financial measures are included in our letter to shareholders. Our letter to shareholders also includes information about our key performance indicators, including customers, in-force premiums, premium per customer, annual dollar retention, gross earned premium, gross loss ratio, gross loss ratio ex CAT and net loss ratio. And the definition of each metric, why each is useful to investors and how we use each to monitor and manage our business. I'd also like to bring your attention to our upcoming Investor Day to be held on November 19, 2024 in New York City. We will be providing detailed updates on our strategic expansion plans, operating efficiencies and growth trajectory. Hope to see you there. With that, I'll turn the call over to Daniel for some opening remarks. Daniel? Daniel Schreiber: Good morning and thank you for joining us to discuss Lemonade's results for Q2 2024. I'm happy to report continued consistent and strong progress across the board. Year-on-year, our top line grew 22%. Our adjusted EBITDA loss improved by 18% and our gross profit grew by a remarkable 155%. Despite a quarter that saw elevated CAT losses across the industry, our loss ratio came in at 79%, improving 15 points year-on-year. This is no accident. We have been laser-focused on reducing CAT volatility by growing products with lower CAT exposure, notably pet and renters, geographic diversification of growth, including via Europe where we recently launched homeowners insurance in the U.K. and France, continuing to sell Lemonade homeowners insurance in the U.S. only where our AI predicts attractive LTVs and simultaneously placing some home premiums with third parties in selected geographies. Tellingly, our trailing 12-month gross loss ratio continued its decline for the fourth consecutive quarter, also hitting 79%. We think this number in preference to the quarterly results neutralizes some of the volatility and provides a more bankable indication of our ongoing performance. But whatever your preferred metric is, the picture that emerges is the same. Great progress that enables us to deliver notably expanded gross margins. I'm also pleased to share that Q2 was net cash flow positive. We expect cash flow to be positive consistently here on out, excepting only Q4 this year where various timing issues will make that quarter a one-off exception. In any event, we don't expect our cash balances to decline by more than 1% or maybe 2% before climbing consistently. With these updates, we feel exceedingly well positioned to continue investing in robust and profitable growth. I also wanted to put a spotlight on our giveback program for a moment. A couple of weeks ago, we announced our contribution of more than $2 million to 43 nonprofits around the globe, our eighth consecutive year of giving back to dozens of local and global charities chosen by our customers. Social impact is a core pillar of who we are at Lemonade. Our contribution since inception now exceeds $10 million and this program reflects the collective power of the Lemonade community and its ability to drive meaningful change. It's something we're very proud of and we know this is only the beginning. Next, I'd like to hand over to Shai to tell you more about our recent efficiency improvements unlocked by our technology. Shai? Shai Wininger: Thanks, Daniel. On the expense side, we've continued to deliver on our autonomous organization vision with remarkable stability. Our operating expense base, excluding growth spend which is now financed via the synthetic agents program, was unchanged year-over-year. This underscores the scalability of our tech vision which leads to measurable efficiency in our operations. This dynamic we're witnessing, robust predictable IFP growth alongside an expense base that remains comparatively steady and even shrinks at times, isn't a short-term anomaly. We expect this trend to persist in the coming quarters and years as we approach sustainable profitability at scale. This trajectory is a testament of the power of our technology-first approach and our commitment to operational excellence. Investors and analysts often ask about the practical impact of our investments in building our own tech-based insurance stack. I believe our recent quarterly results clearly demonstrate that. With large parts of our business running on code rather than people, I believe our tech obsession is paying off in a big way and helps separate us from incumbents in visible, measurable and impactful ways. What we've achieved so far is just the beginning. Our team has been hard at work on our next-generation technology platform, codename L2 which is designed to bring step-change improvements to areas such as underwriting, insurance operations, compliance and product development. With L2, we anticipate additional efficiency gains alongside acceleration of our product operations. These improvements should position us to adapt quickly to market changes as well as capitalize on new opportunities, products, markets and even business models. The potential impact of L2 extends beyond mere cost savings. It's about reimagining how insurance companies should operate in the AI era. We look forward to sharing more about all this at our Investor Day, November 19 in New York City. And with that, let me hand it over to Tim to cover our financial results and outlook in greater detail. Tim? Tim Bixby: Great. Thanks, Shai. I'll review highlights of our Q2 results and provide our expectations for Q3 and the full year and then we'll take some questions. Overall, it was again a terrific quarter, with results very much in line with or better than expectations and continued notable loss ratio improvement across the board. In-force premium grew 22% to $839 million, while customer count increased by 14% to 2.2 million. Premium per customer increased 8% versus the prior year to $387, driven primarily by rate increases. Annual dollar retention or ADR was 88%, up 1 percentage point since this time last year. Gross earned premium in Q2 increased 22% as compared to the prior year to $200 million, in line with IFP growth. Our revenue in Q2 increased 17% from the prior year to $122 million. The growth in revenue was driven by the increase in gross earned premium, a slightly higher effective ceding commission rate under our quota share reinsurance as well as a 45% increase in investment income. Our gross loss ratio was 79% for Q2 as compared to 94% in Q2 2023 and 79% in Q1 2024. The impact of CATs in Q2 was roughly 17 percentage points within the gross loss ratio, nearly all driven by convective storm and winter storm activity. Absent this total CAT impact, the underlying gross loss ratio ex-CAT was 62%, in line with the prior quarter and fully 10 percentage points better than the prior year. Prior period development had a roughly 3% favorable impact on gross loss ratio in the quarter. Notably, the CAT prior period development was about 2% unfavorable while non-CAT was about 5% favorable, netting out to the 3% favorable impact. Trailing 12 months, our TTM loss ratio, was about 79% or 12 points better year-on-year and 4 points better sequentially. From a product perspective, gross loss ratio improved notably for all products with year-on-year improvements ranging from 5% to 30%. Operating expenses, excluding loss and loss adjustment expense, increased 13% to $107 million in Q2 as compared to the prior year. The increase of $12 million year-on-year was driven predominantly by an increase in growth acquisition spending within sales and marketing expenses. Other insurance expense grew 25% in Q2 versus the prior year, in line with the growth of earned premium, primarily in support of our increased investment in rate filing capacity. Total sales and marketing expense increased by $12 million as noted or 48%, primarily due to the increased gross spend, partially offset by lower personnel-related costs driven by efficiency gains. Total gross spend in the quarter was about $26 million, roughly double the $13 million figure in the prior year. We continue to utilize our synthetic agents growth funding program and have financed 80% of our growth spend since the start of the year. As a reminder, you'll see 100% of our growth spend flows through the P&L as always, while the impact of the new growth mechanism of synthetic agents is visible on the cash flow statement and balance sheet. And the net financing to date under this agreement is about $44 million as of June 30. Technology development expense declined 12% year-on-year to $21 million due primarily to personnel cost efficiencies, while G&A expense also declined 3% as compared to the prior year to $30 million, primarily due to both lower personnel and insurance expenses. Personnel expense and headcount control continue to be a high priority. Total headcount is down about 9% as compared to the prior year at 1,211, while the top line IFP as noted grew about 22%. Including outsourced personnel expense which has been part of our strategy for several years, this expense improvement rate would be similar. Our net loss was a loss of $57 million in Q2 or $0.81 per share which is a 15% improvement as compared to the second quarter a year ago. Our adjusted EBITDA loss was a loss of $43 million in Q2, a roughly 18% improvement year-on-year. Our total cash, cash equivalents and investments ended the quarter at approximately $931 million, up $4 million versus the prior quarter, showing a nice positive net cash flow trend in the quarter. This positive net cash flow contrasts markedly with a net use of cash of $51 million in the same quarter in the prior year. With these metrics in mind, I'll outline our specific financial expectations for the third quarter and full year 2024. Our expectations for the full year remain unchanged as compared to our guidance on our Q1 earnings call. As has been the case in some prior years, there's a notable seasonal difference in our expected results in Q3 and Q4. Specifically, Q3 is typically our highest growth spend quarter which tends to drive up sales and marketing spend and also, typically a higher expected loss ratio as compared to Q4. Our third quarter guidance and our implied Q4 guidance reflect these seasonal themes. From a gross spend perspective, we expect to invest roughly $25 million more in Q3 as compared to Q3 in the prior year to generate profitable customers with a healthy lifetime value. At the same time, we will be proactively nonrenewing customers with unhealthy lifetime value, specifically certain CAT-exposed homeowners policies. As our AIs have become increasingly good at identifying such policies and as our latest underwriting rules have been approved by regulators, we now have the ability to identify older policies that we wouldn't write today. We expect this to remove between $20 million and $25 million of IFP from our book in the second half of 2024, dampening growth in the immediate term while concurrently boosting cash flow and profitability in the medium term and further reducing CAT volatility. Importantly, though, our IFP guidance for the year reflects these plans and remains unchanged. For the third quarter of 2024, we expect in-force premium at September 30 of between $875 million and $879 million, gross earned premium between $208 million and $210 million, revenue between $124 million and $126 million and an adjusted EBITDA loss of between $58 million and $56 million. We expect stock-based compensation expense of approximately $16 million, capital expenditures approximately $3 million and a weighted average share count for the quarter of approximately 71 million shares. And for the full year of 2024, we expect in-force premium at December 31 of between $940 million and $944 million, gross earned premium between $818 million and $822 million, revenue between $511 million and $515 million and adjusted EBITDA loss of between $155 million and $151 million. And we expect stock-based compensation for the full year of approximately $64 million, CapEx of approximately $10 million and a weighted average share count of approximately 71 million shares. And with that, I'd like to hand things back over to Shai to answer some questions from a few of our retail investors. Shai? A - Shai Wininger: Thanks, Tim. We now turn it over to our shareholders' questions submitted through the safe platform. I'll start with Matthew H. who asks, how are we leveraging AI technology to improve underwriting, claim processing and overall customer experience? And are there any major business risks or challenges to further leveraging AI? Thanks, Matthew. We've spoken about this at some depth in prior shareholders' letters. As I shared in the past, we're well underway to leverage AI at every stage of the customer journey as well as in many areas of our internal operations. We do that to drive efficiency, improve our underwriting and enhance customer experience with fast and always available smart service. Our underwriting, customer service and claims management, even employee management, administration, engineering, product operations, all use AI heavily. As an example, in just over a year, we went from a standing start to having a comprehensively rolled out generative AI platform to handle incoming customer communications. We handle e-mail and text communications coming in and we're now handling more than 30% of these interactions with absolutely no human intervention. Progress to date is the tip of the iceberg though and I expect us to continue to focus on additional applications of these technologies, delivering concrete measurable impact to the business and helping us widen the gap between our tech and the competition's. Nomi K. asks if we can share the performance metrics and customer feedback from states where all 5 of Lemonade's insurance products are available and what are the main challenges or limiting factors preventing a broader rollout to additional states and how do we plan to address these? Thank you, Nomi. The specific order of state expansion is generally based on growth potential and expected profitability in those markets as well as prioritization aspects that have to do with focus and resource allocation. We expect cross-selling activity to be an increasingly powerful driver of growth as a result. In Illinois, for example, where we have all of our products available, we're seeing multiline customer rates that are roughly double the rest of the book. We also see other metrics improve, such as superior retention rates after bundling and outstanding customer feedback as measured by NPS. There were several questions about car rollout timing and expectations. And I'll just say that the organization is running around car in a remarkable way and we're expecting the growth rate of car to begin accelerating in the near future as a result. We plan to roll out car several additional states during 2025, with our main considerations being profitability predictions and regulatory approval rates. We aim to operate first in states where we can move quickly and write new business profitably. In the second half and beyond with the unlock of rate adequacy in multiple geographies, we'll be expanding investment in new customer acquisition as well as cross-selling to our existing user base. And now I'll turn the call back to the operator for more questions from our friends from the Street. Operator: [Operator Instructions] Our first question today comes from Jack Matten from BMO. Jack Matten: Just wondering if you could provide some more details on the non-renewals of the CAT-exposed home business. In which states are your actions primarily taking place? And are there particular years of business that you're focused on? I guess in general, if you can talk about any insights that you've learned from your more recent models that led to your decision. Daniel Schreiber: Yes. A couple of thoughts there. In terms of the distribution across states, it's really more of a -- it can be concentrated in states. It's really focused -- tends to be focused more on expected lifetime value which tends to be quite driven by a higher than target loss ratio that tends to be concentrated within the home book almost entirely which is the most challenging loss ratio we have. We've talked a little bit about in the letter the range that we're targeting which is 20 to 25. We talk about a range because it's not a hard number but it's based on what we know and as we're kind of developing that analysis, that feels like the most appropriate range. Important to note that while it puts downward pressure on IFP growth, as all of our -- every customer kind of adds up to that total IFP number, from a cash perspective or a value perspective, it's got a very high ROI. We're taking out much more expected cost than we are taking out contribution from the premium, so it's definitely ROI positive. If you take out, for example, $25 million of IFP with an elevated loss ratio, you can generate, using our own model, something like $50 million or $60 million in net positive value. A little short-term pressure on IFP but over the medium term, long-term value. In terms of timeframe, these tend to be older policies, so our underwriting rules and our AI models get a little bit better every day and so the concentration tends to be business we wrote 2 or 3 or 4 years ago in some cases. And as noted, the vast majority, if not 100% of this business, would be business we wouldn't write today under our current underwriting guidelines. Jack Matten: That's helpful. Thank you. The second question is on capital. Can you talk about the premium to surplus ratio that Lemonade expects to maintain as your business mix evolves? And I guess somewhat relatedly, it looks like your invested asset balance has been falling in recent quarters. Is that something that the company expects to continue doing moving forward? I think just trying to get some insights into that investment income. Thank you. Tim Bixby: Sure. On the capital surplus, we've not talked about that for a while because things are essentially unchanged. Our target is and continues to be a roughly 1:6 ratio of acquired surplus to gross earned premium. And we've got at least a couple of very effective tools in place to help us drive that number to what is arguably sort of best-in-class in the industry. This is what many insurance companies shoot to do. And I think we're performing quite well on that metric. Our quota share structure, our Cayman captive structure, these are really designed not only to mitigate volatility but more importantly to drive -- to enable significant capital surplus efficiency. That's really unchanged at that 1:6 ratio. From a cash investment standpoint, yes, you will note if you kind of charted out the cash balances has increased somewhat as a percentage of the total. That's not so much a concerted strategy. I would expect that trend to moderate or even flatten out before too long. However, the interest rate environment is what it is. We're expecting what you and others are expecting in the market, that there will be perhaps more downward pressure on interest rates than upward pressure and we factored in sort of the most current forecasts into our guidance in terms of what the expected investment income is likely to be. The good news is, our cash investments balance actually went up this quarter in total. We're earning really strong returns on the cash as well as the investments. And so that's something that I would highlight. We foresee that cash and investments balance basically troughing, might drop another 1% or 2% as we noted but that puts us well above a $900 million total cash investments balance from here on out as far as we can see. Compare that to 3 or 4 years ago when there was quite a bit more uncertainty as to our growth trajectory and where that balance might end up, that's a dramatic change and I think it probably has a tremendous foundation for us going forward. Operator: The next question comes from Michael Phillips from Oppenheimer. Michael Phillips: A question first on auto and kind of follow-up from the opening comments about new state expansion as you get into next year. The last 10 I had, I think you were in 11 states. I'm not sure that's still right. As you look out over the next maybe 18 months, given kind of the decent rate environment for auto, it might be slowing down. But should we expect state expansion by say yearend '25 to being close to like 20 states or 40 states or just kind of how aggressively you want to be over the next 18 months? Daniel Schreiber: No, I don't think we'll be at 40 states. And of course, to state the obvious, not all states are born equal. We will be expanding throughout 2025. We haven't given specific numbers and so my answer today is going to remain a little bit vague still. One of the driving factors is going to be the graduation of renters to be car customers. We will be looking and one of the guiding principles Shai spoke about, regulatory environment and some predictive loss ratios. Another one is where we have the largest footprint of renters who have cars but don't have car insurance with us and that will be another driving force. But we're not ready to disclose numbers of states yet. Michael Phillips: Okay, I can appreciate that. Thanks, Daniel. I guess continuing with that, maybe a follow-up on that is, typically, as we're growing in new states, there can be some pressure on our margins in auto. Maybe for you guys, I guess I want to see what -- do you think that might be a bit muted than what normally is the case, given -- I think you've talked about knowledge that you have from your current renters and homeowners customer base and how that can translate into more information in your initial pricing for auto as that starts to grow? Daniel Schreiber: Yes. Look, we are -- I sort of mentioned this before but we are very bullish in the medium to long term on car. We think it's a highly differentiated product with a strong and structural competitive advantage given that at first approximation, all our customers use telematics on an ongoing basis. And whereas at first approximation for the incumbent that's none or 0. This is really a very powerful differentiator quite beside or in addition to the fact that we have really spectacular user experience, very high customer satisfaction levels, etcetera. Going back to my comment earlier about the renters aspect here, yes, we are seeing that renters who buy car insurance have a much, to use your words, muted loss ratio, In fact, their whole economics are dramatically different. The cost of acquisition is effectively 0. You might even conceive a bit as being negative cap because our renters book is very profitable. And then you've got existing customers who ostensibly have paid to be Lemonade customers but they are profitable at the outset and then we get to sell them a car policy with no incremental cost. Again, I'm rounding here but I think a price approximation that holds true. And we have found them to be not only highly profitable because of the absence of any customer acquisition cost but much better because we do use the factors that you said, much better risks. We can price them effectively. We don't see the new business penalty that you see when you usually grow a book. So very, very different unit economics and lifetime value of existing customers. This is really, I think, a strategic pillar that we will expand on during our Investor Day as well later in the year. We do have over 2 million existing customers, many of whom have car insurance, just not with Lemonade. And that opportunity translates into a very, very sizable and ultimately we expect, very profitable opportunity for us. Shai Wininger: Probably also worth noting that the external environment is improving as well. For some time, we and other car providers were chasing a target with inflation's unfavorable impact on cost of repairs and cost of claims. The data is now really showing that that trend has slowed, if not stalled and in some cases may even reverse. And so, chasing that target is now much -- the impact of our rate increases, both those already in place and those we are continuing to work on, have an even greater impact and that really provides a higher level of confidence comfort in our planning for car for the rest of this year and well into next year as well. We noted that our gross loss ratio improvement across our product lines improved anywhere from 5% to 30%. Car was right at the upper end of that range, so we're seeing lots of great indicators. Operator: The next question comes from Tommy McJoynt from Stifel. Tommy Mcjoynt: Tim, kind of going back to the first question that you got on the nonrenewal side, you mentioned the $25 million of non-renewed IFP and that's going to be offset by it sounded like I think you said $50 million to $60 million of sort of net positive value. Let's call it $50 million. Sorry, is that saying that the LTV of those policies, instead of being presumably positive when you wrote it, is now being sort of reassessed at negative $50 million? And hence, by not writing, non-renewing that business, it will now be 0? Just kind of help explain sort of what that $50 million to $60 million number that you mentioned actually is. Tim Bixby: Yes. In rough strokes, the way you described it is right. If a customer has an expected lifetime value let's say of 3x its acquisition cost which is often typical for us, that means over the course of their lifetime, 2, 3, 4 years depending on the product or more, we expect to generate that incremental cash flow or value. What this says is we expect that lifetime value to be a negative $50 million or $60 million in the case I described for an IF, so think of that ratio as sort of a negative 2:1 ratio. I mean it's really almost entirely driven by the elevated loss ratio. If a customer has an expected 150% loss ratio for example and you carry that customer out for a couple 3 years or more, that's the driver. I think you have the analysis right, it's rough justice but it's notable -- notably positive ROI for those changes. Tommy Mcjoynt: Okay, got it. And do you know what the impact on the loss ratio from that sort of $25 million in IFP was in the first half of the year? Or even in absolute dollars, kind of how much sort of operating loss that business generated, contributed? Tim Bixby: Hard to really put a precise number on that. I would think of that range of $20 million to $25 million is over the course of the year, the vast majority in Q3 and Q4. It's really a forward-looking number and expected impact. We have started the process. There was a nominal amount in Q2 but I would say it probably rounds to pretty close to 0. It's really a Q3, Q4 and forward expectation, a little more concentrated in Q3 than Q4. Our loss ratio does -- has borne the burden of that business and so it's really notable I think that our loss ratio improved mid-double digits year-on-year with some of that downward pressure. And so all of these changes, not just rate changes, will have a favorable -- continued favorable impact on the loss ratio going forward. Daniel Schreiber: And Tommy, maybe I'll just add -- sorry, just one other kind of vantage point of color and Tim mentioned this briefly in his comments, this is really a homeowners focused fix. It's the one part of our business that has had pockets of sustained negative LTV. And in addition to being negative in LTV, there have also been an environment that oftentimes we could not get the rate approval. In theory, any risk can be priced adequately but we don't always find regulators affording us that luxury. This is part of the business where we just were not able to get the approvals and don't expect to in any fashion. Otherwise, we would have been kind of shown more forbearance if we thought it was on the cusp of turning profitable. But in addition to being stubbornly unprofitable, it also tends to concentrate very much in volatile parts of the country. Even some of this business were we to get to long-term average profitability, we've always sought to avoid the most CAT-exposed part of our business -- of the country rather, sorry and we have avoided writing in the most CAT exposed places really since our inception in places where we have still found that the volatility is higher than we want now, knowing what we know. We're also taking this opportunity to non-renew that part of the business. Tim Bixby: And maybe just to put a fine point on it based on a couple of questions I've gotten already, I'll answer a question that has not been asked which is, if this number is 25 as we expect it to be, the question might be, would your IFP expectations have been $25 million greater if not for the impact of this? The answer is yes. Yes. Tommy Mcjoynt: Okay, got it. Appreciate that color. And then just quickly, you mentioned the expectations for growth spend in 3Q to be $25 million up year-over-year. Did you give a 4Q number? Or do we have the full year kind of expectation? Tim Bixby: Yes. I would think of the full year as really unchanged. The timing over the course of the quarters has changed somewhat. The guidance we gave historically is sort of between $100 and $110 million, $105 million is the number we've mentioned. I think we're still sort of on track and planning to spend that rough amount over the course of the full year. We have adjusted the timing of that somewhat a little bit more than initially planned in Q3 than otherwise. Q3 is typically the highest gross spend quarter in any case in most years. And the fourth quarter, obviously, if you kind of do the math, will be somewhat elevated as well. Q1 was really the ramp-up quarter and so it's a pretty steep climb and we expect Q3 to be at the rate we disclosed. Operator: The next question comes from Bob Huang from Morgan Stanley (NYSE:MS). Bob Huang: Great. First one is on your 17 points of improvement in CAT losses which was -- I mean, sorry, 17 points of the impact on CAT losses which is a 5-point improvement. Directionally speaking, that's obviously similar to the industry. As you non-renew the homeowner side, is there a run rate expectation on what CAT losses should look like going forward? Can you give us a little bit more color on just like how we should think about that impact? I know that you already talked about quite a bit on the impact on the other side of things on the homeowner renewal. Just to see if there's any additional color on the CAT side. Tim Bixby: That's probably a little bit beyond some of the guidance we've given. I can give a little bit of the way you might think about it. Our home business as a share of the total business is coming down as a percentage but just modestly. I think it came in the quarter and this is home and condo combined, came in about just under 20% and it's down a couple of points year-on-year. And so, you can kind of back into -- if we were to take $25 million of IFP out, back into what that impact might be. In terms of the specific reduction on loss ratio, it's a little tricky to do that. I'm not going to venture that far. But CAT is really isolated almost entirely to home, not quite 100% but primarily home. And really, these are the most challenging policies obviously that we'll go after. I'll leave it to you to kind of do some math but that's how I would go about it. Bob Huang: Okay. Maybe second one on just how we should think about ceding commission. If we look at a ceding commission as a percent of premium last call it 5 quarters, it's generally about 20%. This quarter was notably lower than that. Is this more of a one-time thing? What's driving that? And should it go back to about 20% of premium going forward? Tim Bixby: Yes. A couple of ways to think about the ceding commission. Year-on-year there is a change because there was a change in the structure. The prior year was a fixed structure up through our July renewal a year ago and so you saw in the face of the P&L roughly a 20% effective commission. Now our commission, because of the way we do the accounting, it's split into 2 pieces, so our effective commission rate was about -- running about 23%. But the most important thing was it was static. It was a fixed number. That's now variable. That's helpful in some ways but a little less -- a little trickier when you're building a model. But the net difference over -- I think one way to think about it is to look at Q1 and Q2, the net commission was about 18% versus 20%, so modestly lower but just by a couple of points. But more volatility, more variability, so Q1 was a fair bit lower, Q2 was higher. We'll continue to see that move around a little bit quarter-to-quarter but that gets trued up as you go through the course of the year. I would expect -- we'll give as much of an indication on that as we can but I would think of it as a couple of points lower than prior year but there are some offsets to that as well. Our renewal this year was similar. It is also a sliding scale that begins this month, began in July. But the scale and the expected effective rate will actually be a little bit better. At this point, it's hard to say if it gets back to the prior level but it should be up maybe 1 point or 2 on any sort of apples-to-apples comparison so slightly better terms in this renewal. Probably also -- probably also worth answering another -- I like answering questions that weren't asked, so I'll throw in another one which is, because a loss ratio varies obviously quarter-to-quarter, the typical pattern has been a Q4 loss ratio that's the lowest of the 4 quarters. That's happened often in prior years. We expect it will happen this year. And if that plays out as expected, that has a pretty strong favorable impact on that commission rate. And so again, a little more volatile quarter-to-quarter but if things play out as expected and as historical patterns, you'd see a nice favorable impact over the course of the year. It gets us back on track versus some of the prior quarters. It can be a little bit lower commission rate. Operator: Thank you. The next question comes from Matthew O'Neill from FT Partners. Matthew O'Neill: I just wanted to ask a little bit about premium per customer. It's been growing impressively but the rate may be decelerating slightly. I was just curious if you could give us an assessment of kind of how far through the rate increases you are on the in-force book? Tim Bixby: Yes. That can vary quarter-to-quarter. It has been a pretty steady contributor but our customer count was a stronger contributor to growth this year quarter-on-quarter than the price increase. It varies by product. As I mentioned in car, you're seeing a pretty dramatic impact in rent, much less so because it's really so optimized. The loss ratio is such a strong loss ratio as it is and pricing is quite good. So it varies by product. In terms of where we are, I think 2 or 3 quarters ago we mentioned that we were sort of halfway through. There's $100 million or so remaining to earn in. That's more or less unchanged because as we -- the pace of us earning in rate and the pace of us filing for new rates has been roughly in balance. I think of us in a similar spot now where there's still plenty of rate to earn in. Obviously, that doesn't last forever. There will always be rate filings and always increases even in a low or no inflation environment but we're quite a ways away from that. That is factored into our -- the Q3, Q4 guidance that we'll continue to earn at that pace and it will go into next year. Things that are approved and in place will earn well into next year. Matthew O'Neill: Thanks. That's very helpful. And maybe just a quick one and I realize I may be jumping the gun on potential Investor Day content but I know you've spoken about the long-term or ultimate target for the loss ratio in the high 60s to 70s [ph]. I don't know if there's kind of an internal or a way to think about the ultimate target for the expense ratio going forward. Daniel Schreiber: We are determined to have an expense load that will be absolutely better than the industry. We're beginning to look less at ratios because we also intend to be a price leader. And that might not give you as clear a picture of just how advantaged we think we're becoming due to our technology but it will reflect itself in I think best-in-class expense ratio and even more dramatically in actual expense load. If you kind of put it on an apples-to-apples basis with the same premium and that's being charged by competitors, it will manifest itself more powerfully still than when you look at it against our own lower premiums because we think we get to pass some of those savings on to our customers and that can accelerate growth, accelerate retention, lower cost of acquisition and allow us to achieve our ultimate and rather ambitious goals for the company. But if I answer your question kind of more straightforwardly, we think that at scale, we will be in the teens. We disclosed last quarter that the LAE component of our expense stack has already achieved parity with the very best in the industry. We reported a 7.6% LAE last quarter. Shai mentioned some of the efficiencies that we're gaining through automation and we're really seeing these rollout very, very powerfully in some of the numbers that we shared earlier about what's happened to our headcount expense, what's happened to our what we're calling IFP per human, how many people were needed to gen -- as we've doubled our book, we've been able to over the course of the last few years, we've been able to halve the ratio of people needed to generate every dollar of premium. We're seeing very dramatic advancements, all of which will ultimately reflect themselves in our competitive expense structure, some of which will manifest as lower prices and some of which will manifest we believe still as best-in-class expense ratio. That said, I'll add to that and there was reference to this in the letter as well, we think of for structural reasons that may be obvious and some that are less than obvious, we think of growth as the gift that keeps on giving. We really think that the number that I just gave and the direction that I just outlined will become -- at the moment, you can look at various numbers in the field in action and I referenced a few of them. I think a few years from now, it will be unmissable. It will be kind of glaringly obvious and the difference between now and then is that will continue to grow. And as we continue to grow, as we've doubled our business while holding our expense structure flat, we kind of shared that over the course of the last few years, we've seen expense net of customer acquisition actually decline even as we've enjoyed record growth. Clearly, that moving forward, holding expenses relatively flat and really start seeing how this generates a very, very profitable business. But that dynamic will continue to manifest with ever greater force as we continue to grow. When we double our business, you will see it with greater clarity. When we 10x our business, as I say, it will be glaringly obvious. Operator: Thank you. The next question comes from Yaron Kinar from Jefferies. Unidentified Analyst: This is Charlie [ph] on for Yaron. A couple of questions. The first one, with the decision to non-renew certain CAT-exposed homeowners, was that previously contemplated in guidance? Tim Bixby: No. Unidentified Analyst: Okay, thanks. And then are you guys able to give us CAT prior year development and LAE on a net basis? Tim Bixby: The prior period development, you can split into 2 pieces. It was 3 points favorable. It was 2 points unfavorable from a CAT perspective and 5 points favorable from a non-CAT perspective. Netting out to the 3 favorable. Unidentified Analyst: Okay. Sorry. And just to clarify, was that gross CAT or net CAT impact? Tim Bixby: Yes. And then that breakdown would be roughly similar on a net basis, the prior period development. The total CAT impact on a net basis was about 15 points, whereas on a gross basis, it was about 17 points. LAE came in about 8%. It's been 7 point, mid-7s, edged up a little bit but in that sort of 7% to 8% range, by 8% this quarter. Unidentified Analyst: Okay, great. And then last one if I could, just looking at the underlying loss ratio, it looks like contemplating those components, you guys saw about 22 points of underlying improvement. But if we look at the first quarter of 24% on a year-over-year basis from first quarter of '23, it looks like it was relatively flat. Is there anything underlying that that you guys could provide some color on? Tim Bixby: Pretty distinct quarters. Yes, on a full quarter basis, it was pretty stable. I think that it's really important to look at the year-on-year comparison from a seasonal perspective. And on a trailing 12 months basis obviously continued significant improvement. Any given comparison of quarters, you might see some trends that are interesting but not necessarily indicative of a longer-term trend. Nothing in particular to call out that was distinct between Q1 and Q2. Q2 was a really interesting quarter as it evolved, really significant impacts early in the quarter and really dramatic favorable outcomes by the end of the quarter, netting out to what ended up to be a quarter that was even better, just modestly better than our expectations. The months can be pretty unpredictable but the quarters are a little more predictable. Operator: [Operator Instructions] We have a follow-up question from Bob Huang from Morgan Stanley. Bob Huang: Maybe just a follow-up on the PYD question. 5 points of favorable on everything else and 2 points unfavorable on the CAT PYD. On the 5 points, can you give us maybe a little bit more color on the geography of those? Like what are those 5 points coming from if possible? Sorry if I missed this a little earlier. Daniel Schreiber: We did not. It's a little more concentrated in the pet product but it was distributed across products other than home. The CATs are primarily a home dynamic and the increase was driven by those really significant storms from a year ago and a bit earlier this year that have evolved, continue to evolve. But the underlying favorable development I think is really testament to the non-CAT portion of the business which is really all the product lines other than home. Bob Huang: Okay. Basically, CAT was unfavorable and dogs were favorable. Thank you for that, that's very helpful. On the other one, maybe on the LTV to CAC side. I know that you talked about previously, you kind of mentioned LTV to CAC is about 3x, then that would be the ratio. And then I think one thing we're trying to figure out is that if you have these homeowner non-renewals, going forward, does that 3x LTV to CAC equation still holds? How should we think about that renewal impact on the LTV to CAC? Tim Bixby: Yes. LTV to CAC is an important metric but it's a forward metric. It's based on a model. It's based on all the information we collect. it improves a little bit every day, every week, every month as we go forward. When we acquired that business, when our models were by definition less sophisticated than today, 2, 3, 4 years ago, we expected those to be profitable customers. As we learn more in our models and our existing customer base and claims activity, invariably a certain portion of the customer base, their expected LTV will change. For newly acquired customers, there is no change, so we expect customers we acquire today and tomorrow to be fully profitable. We've seen a ratio greater than 3:1. 3:1 is a good rule of thumb but we've seen certainly periods where it's 3.5 or 4 or more. There tends to be a little bit more pressure when you spend more. We're spending double today what we spent a year ago and that tends to put downward pressure on LTV to CAC but that's a good thing. And we earn our way in and we develop channels, we expand our spending. And overall, 3:1 is a good metric to think about. I'll add one other comment in that area which I think is helpful which is LTV to CAC is kind of policy by policy focused. And if you look at our spending per net added customer, you might think things got more expensive for us in the quarter. And while that exact math is correct, it's important to look at IFP. Net added IFP, gross added IFP really is what we're acquiring with that tax spend. And by that measure, we were actually more efficient in the second quarter than we were in the year-ago quarter and even in the prior quarter. All around, that number is stable and that's what's enabling us to really say we're very comfortable with growth rates that are accelerating. You started out the year in the low 20s, going into the mid-20s and now we're pushing towards the high 20s growth rate and that's a core driver for them. Daniel Schreiber: Maybe I'll talk about a comment of color commentary, Bob, as well. LTV to CAC, you always want it to be as high as possible per customer. But truly, you want to keep growing it until you hit the marginal customer where the LTV equals CAC. In other words, if you could spend $1 and get $1.10 instead of getting $3, that is still marginally good for the business, you're still growing profitable business. And since our LTV calculations take onboard the time value of money that's already factored in at a fairly robust discount rate. While LTV to CAC is 3, that's our average, we have many higher customers than that. We acquired many customers in the double digits of LTV to CAC as well. When we'll stop investing is when we hit the marginal customer who's closer to an LTV to CAC of 1. We take a bit of a margin of safety but conceptually, that is the philosophy. We want every marginally profitable customer, we want them and we will continue to grow using that. We have never deviated from that. We have never tried to acquire customers of a negative LTV. Sometimes, we find this confusing to some investors because in the short term, they do customer acquisition can impact our financials negatively in the short term. The year in which you spend that CAC, because we are not an agent-based business and we pay all -- we take all our pain upfront, we earn it back over time. Therefore, when we grow, sometimes it can appear to be a near-term loss but that is just the nature of the flow of time. Fundamentally, it's about spending $1 now and getting $3 back in today's terms. And if that means that in the near term, we take a hit to our EBITDA, we're okay with that. We don't take a hit to our cash because we've got a synthetic agent program in place, so we've neutralized the trough in terms of the cash, in terms of EBITDA. Those things will work their way out during the course of the lifetime of the customer. At any rate, because of that, we have always sought to grow customers on an LTV to CAC basis, never acquiring knowingly negative LTV business. Over the course of the last couple of years with inflationary pressures and others, larger swaths of the nation and of our portfolio were hard to grow in an LTV positive environment and we've spoken about that and we slowed our growth which we're now reaccelerating. And much of those segments of our business have become profitable over time as we got to adequacy and we've spoken about this, we were able to recover them back to where we thought they would be all along. What we're talking about today for the first time is that in addition to being conservative and careful and never knowingly writing negative business and proactively working to bring back into profitability any business that fell out of it and largely succeeding, we're also not tolerating business that has fallen between the cracks and we've not been able to bring back to profitability. Not only are we not writing knowingly unprofitable business, as we never have, we are now not renewing such business either, having in some places, exhausted in the near term what rate can deliver. And therefore, the philosophy is the same philosophy, the profitability focus of the business has been the same consistently. But now actually not really slowing down in places that aren't profitable but even potentially going into reverse markets that don't contribute. And Tim's earlier comment that, yes, you may see a hit, a potential hit of $25 million to IFP, we're reiterated guidance. We think we're going to manage that within the guidance already given. We think that we're overdelivering for the year and we have that spare to be able to hit guidance notwithstanding this. You won't see a hit to the IFP but it could have been much higher, as Tim said. But we've always been focused not mainly on growing IFP but in growing the total value of the book and this really as a boon to that, as Tim said, $50 million, $60 million of LTV added to our business because of this decision. Operator: Thank you. That was our final question for today. So this does conclude today's call. Thank you all for joining. You may now disconnect your lines.

Lemonade, Inc. (LMND) Q2 2024 Earnings Call Transcript

Yael Wissner-Levy - Vice President of Communications Daniel Schreiber - Co-Founder & Chief Executive Officer Shai Wininger - President & Co-Founder Tim Bixby - Chief Financial Officer Hello and welcome everyone to the Lemonade Q2 2024 Earnings Call. My name is Maxine [ph] and I'll be coordinating the call today. [Operator Instructions] I will now hand you over to Yael Wissner-Levy, VP, Communications at Lemonade to begin. Yael, please go ahead when you are ready. Yael Wissner-Levy Good morning and welcome to Lemonade's second quarter 2024 earnings call. My name is Yael Wissner-Levy and I'm the VP Communications at Lemonade. Joining me today to discuss our results are Daniel Schreiber, CEO and Co-Founder; Shai Wininger, President and Co-Founder; and Tim Bixby, our Chief Financial Officer. A letter to shareholders covering the company's second quarter 2024 financial results is available on our Investor Relations website, investor.lemonade.com. Before we begin, I would like to remind you that management's remarks on this call may contain forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Actual results may differ materially from those indicated by these forward-looking statements as a result of various important factors, including those discussed in the Risk Factors section of our 2023 Form 10-Q filed with the SEC on May 1, 2024 and our other filings with the SEC. Any forward-looking statements made on this call represent our views only as of today and we undertake no obligation to update them. We will be referring to certain non-GAAP financial measures on today's call, such as adjusted EBITDA and adjusted gross profit which we believe may be important to investors to assess our operating performance. Reconciliations of these non-GAAP financial measures to the most direct comparable GAAP financial measures are included in our letter to shareholders. Our letter to shareholders also includes information about our key performance indicators, including customers, in-force premiums, premium per customer, annual dollar retention, gross earned premium, gross loss ratio, gross loss ratio ex CAT and net loss ratio. And the definition of each metric, why each is useful to investors and how we use each to monitor and manage our business. I'd also like to bring your attention to our upcoming Investor Day to be held on November 19, 2024 in New York City. We will be providing detailed updates on our strategic expansion plans, operating efficiencies and growth trajectory. Hope to see you there. With that, I'll turn the call over to Daniel for some opening remarks. Daniel? Daniel Schreiber Good morning and thank you for joining us to discuss Lemonade's results for Q2 2024. I'm happy to report continued consistent and strong progress across the board. Year-on-year, our top line grew 22%. Our adjusted EBITDA loss improved by 18% and our gross profit grew by a remarkable 155%. Despite a quarter that saw elevated CAT losses across the industry, our loss ratio came in at 79%, improving 15 points year-on-year. This is no accident. We have been laser-focused on reducing CAT volatility by growing products with lower CAT exposure, notably pet and renters, geographic diversification of growth, including via Europe where we recently launched homeowners insurance in the U.K. and France, continuing to sell Lemonade homeowners insurance in the U.S. only where our AI predicts attractive LTVs and simultaneously placing some home premiums with third parties in selected geographies. Tellingly, our trailing 12-month gross loss ratio continued its decline for the fourth consecutive quarter, also hitting 79%. We think this number in preference to the quarterly results neutralizes some of the volatility and provides a more bankable indication of our ongoing performance. But whatever your preferred metric is, the picture that emerges is the same. Great progress that enables us to deliver notably expanded gross margins. I'm also pleased to share that Q2 was net cash flow positive. We expect cash flow to be positive consistently here on out, excepting only Q4 this year where various timing issues will make that quarter a one-off exception. In any event, we don't expect our cash balances to decline by more than 1% or maybe 2% before climbing consistently. With these updates, we feel exceedingly well positioned to continue investing in robust and profitable growth. I also wanted to put a spotlight on our giveback program for a moment. A couple of weeks ago, we announced our contribution of more than $2 million to 43 nonprofits around the globe, our eighth consecutive year of giving back to dozens of local and global charities chosen by our customers. Social impact is a core pillar of who we are at Lemonade. Our contribution since inception now exceeds $10 million and this program reflects the collective power of the Lemonade community and its ability to drive meaningful change. It's something we're very proud of and we know this is only the beginning. Next, I'd like to hand over to Shai to tell you more about our recent efficiency improvements unlocked by our technology. Shai? Shai Wininger Thanks, Daniel. On the expense side, we've continued to deliver on our autonomous organization vision with remarkable stability. Our operating expense base, excluding growth spend which is now financed via the synthetic agents program, was unchanged year-over-year. This underscores the scalability of our tech vision which leads to measurable efficiency in our operations. This dynamic we're witnessing, robust predictable IFP growth alongside an expense base that remains comparatively steady and even shrinks at times, isn't a short-term anomaly. We expect this trend to persist in the coming quarters and years as we approach sustainable profitability at scale. This trajectory is a testament of the power of our technology-first approach and our commitment to operational excellence. Investors and analysts often ask about the practical impact of our investments in building our own tech-based insurance stack. I believe our recent quarterly results clearly demonstrate that. With large parts of our business running on code rather than people, I believe our tech obsession is paying off in a big way and helps separate us from incumbents in visible, measurable and impactful ways. What we've achieved so far is just the beginning. Our team has been hard at work on our next-generation technology platform, codename L2 which is designed to bring step-change improvements to areas such as underwriting, insurance operations, compliance and product development. With L2, we anticipate additional efficiency gains alongside acceleration of our product operations. These improvements should position us to adapt quickly to market changes as well as capitalize on new opportunities, products, markets and even business models. The potential impact of L2 extends beyond mere cost savings. It's about reimagining how insurance companies should operate in the AI era. We look forward to sharing more about all this at our Investor Day, November 19 in New York City. And with that, let me hand it over to Tim to cover our financial results and outlook in greater detail. Tim? Tim Bixby Great. Thanks, Shai. I'll review highlights of our Q2 results and provide our expectations for Q3 and the full year and then we'll take some questions. Overall, it was again a terrific quarter, with results very much in line with or better than expectations and continued notable loss ratio improvement across the board. In-force premium grew 22% to $839 million, while customer count increased by 14% to 2.2 million. Premium per customer increased 8% versus the prior year to $387, driven primarily by rate increases. Annual dollar retention or ADR was 88%, up 1 percentage point since this time last year. Gross earned premium in Q2 increased 22% as compared to the prior year to $200 million, in line with IFP growth. Our revenue in Q2 increased 17% from the prior year to $122 million. The growth in revenue was driven by the increase in gross earned premium, a slightly higher effective ceding commission rate under our quota share reinsurance as well as a 45% increase in investment income. Our gross loss ratio was 79% for Q2 as compared to 94% in Q2 2023 and 79% in Q1 2024. The impact of CATs in Q2 was roughly 17 percentage points within the gross loss ratio, nearly all driven by convective storm and winter storm activity. Absent this total CAT impact, the underlying gross loss ratio ex-CAT was 62%, in line with the prior quarter and fully 10 percentage points better than the prior year. Prior period development had a roughly 3% favorable impact on gross loss ratio in the quarter. Notably, the CAT prior period development was about 2% unfavorable while non-CAT was about 5% favorable, netting out to the 3% favorable impact. Trailing 12 months, our TTM loss ratio, was about 79% or 12 points better year-on-year and 4 points better sequentially. From a product perspective, gross loss ratio improved notably for all products with year-on-year improvements ranging from 5% to 30%. Operating expenses, excluding loss and loss adjustment expense, increased 13% to $107 million in Q2 as compared to the prior year. The increase of $12 million year-on-year was driven predominantly by an increase in growth acquisition spending within sales and marketing expenses. Other insurance expense grew 25% in Q2 versus the prior year, in line with the growth of earned premium, primarily in support of our increased investment in rate filing capacity. Total sales and marketing expense increased by $12 million as noted or 48%, primarily due to the increased gross spend, partially offset by lower personnel-related costs driven by efficiency gains. Total gross spend in the quarter was about $26 million, roughly double the $13 million figure in the prior year. We continue to utilize our synthetic agents growth funding program and have financed 80% of our growth spend since the start of the year. As a reminder, you'll see 100% of our growth spend flows through the P&L as always, while the impact of the new growth mechanism of synthetic agents is visible on the cash flow statement and balance sheet. And the net financing to date under this agreement is about $44 million as of June 30. Technology development expense declined 12% year-on-year to $21 million due primarily to personnel cost efficiencies, while G&A expense also declined 3% as compared to the prior year to $30 million, primarily due to both lower personnel and insurance expenses. Personnel expense and headcount control continue to be a high priority. Total headcount is down about 9% as compared to the prior year at 1,211, while the top line IFP as noted grew about 22%. Including outsourced personnel expense which has been part of our strategy for several years, this expense improvement rate would be similar. Our net loss was a loss of $57 million in Q2 or $0.81 per share which is a 15% improvement as compared to the second quarter a year ago. Our adjusted EBITDA loss was a loss of $43 million in Q2, a roughly 18% improvement year-on-year. Our total cash, cash equivalents and investments ended the quarter at approximately $931 million, up $4 million versus the prior quarter, showing a nice positive net cash flow trend in the quarter. This positive net cash flow contrasts markedly with a net use of cash of $51 million in the same quarter in the prior year. With these metrics in mind, I'll outline our specific financial expectations for the third quarter and full year 2024. Our expectations for the full year remain unchanged as compared to our guidance on our Q1 earnings call. As has been the case in some prior years, there's a notable seasonal difference in our expected results in Q3 and Q4. Specifically, Q3 is typically our highest growth spend quarter which tends to drive up sales and marketing spend and also, typically a higher expected loss ratio as compared to Q4. Our third quarter guidance and our implied Q4 guidance reflect these seasonal themes. From a gross spend perspective, we expect to invest roughly $25 million more in Q3 as compared to Q3 in the prior year to generate profitable customers with a healthy lifetime value. At the same time, we will be proactively nonrenewing customers with unhealthy lifetime value, specifically certain CAT-exposed homeowners policies. As our AIs have become increasingly good at identifying such policies and as our latest underwriting rules have been approved by regulators, we now have the ability to identify older policies that we wouldn't write today. We expect this to remove between $20 million and $25 million of IFP from our book in the second half of 2024, dampening growth in the immediate term while concurrently boosting cash flow and profitability in the medium term and further reducing CAT volatility. Importantly, though, our IFP guidance for the year reflects these plans and remains unchanged. For the third quarter of 2024, we expect in-force premium at September 30 of between $875 million and $879 million, gross earned premium between $208 million and $210 million, revenue between $124 million and $126 million and an adjusted EBITDA loss of between $58 million and $56 million. We expect stock-based compensation expense of approximately $16 million, capital expenditures approximately $3 million and a weighted average share count for the quarter of approximately 71 million shares. And for the full year of 2024, we expect in-force premium at December 31 of between $940 million and $944 million, gross earned premium between $818 million and $822 million, revenue between $511 million and $515 million and adjusted EBITDA loss of between $155 million and $151 million. And we expect stock-based compensation for the full year of approximately $64 million, CapEx of approximately $10 million and a weighted average share count of approximately 71 million shares. And with that, I'd like to hand things back over to Shai to answer some questions from a few of our retail investors. Shai? Thanks, Tim. We now turn it over to our shareholders' questions submitted through the safe platform. I'll start with Matthew H. who asks, how are we leveraging AI technology to improve underwriting, claim processing and overall customer experience? And are there any major business risks or challenges to further leveraging AI? Thanks, Matthew. We've spoken about this at some depth in prior shareholders' letters. As I shared in the past, we're well underway to leverage AI at every stage of the customer journey as well as in many areas of our internal operations. We do that to drive efficiency, improve our underwriting and enhance customer experience with fast and always available smart service. Our underwriting, customer service and claims management, even employee management, administration, engineering, product operations, all use AI heavily. As an example, in just over a year, we went from a standing start to having a comprehensively rolled out generative AI platform to handle incoming customer communications. We handle e-mail and text communications coming in and we're now handling more than 30% of these interactions with absolutely no human intervention. Progress to date is the tip of the iceberg though and I expect us to continue to focus on additional applications of these technologies, delivering concrete measurable impact to the business and helping us widen the gap between our tech and the competition's. Nomi K. asks if we can share the performance metrics and customer feedback from states where all 5 of Lemonade's insurance products are available and what are the main challenges or limiting factors preventing a broader rollout to additional states and how do we plan to address these? Thank you, Nomi. The specific order of state expansion is generally based on growth potential and expected profitability in those markets as well as prioritization aspects that have to do with focus and resource allocation. We expect cross-selling activity to be an increasingly powerful driver of growth as a result. In Illinois, for example, where we have all of our products available, we're seeing multiline customer rates that are roughly double the rest of the book. We also see other metrics improve, such as superior retention rates after bundling and outstanding customer feedback as measured by NPS. There were several questions about car rollout timing and expectations. And I'll just say that the organization is running around car in a remarkable way and we're expecting the growth rate of car to begin accelerating in the near future as a result. We plan to roll out car several additional states during 2025, with our main considerations being profitability predictions and regulatory approval rates. We aim to operate first in states where we can move quickly and write new business profitably. In the second half and beyond with the unlock of rate adequacy in multiple geographies, we'll be expanding investment in new customer acquisition as well as cross-selling to our existing user base. And now I'll turn the call back to the operator for more questions from our friends from the Street. [Operator Instructions] Our first question today comes from Jack Matten from BMO. Jack Matten Just wondering if you could provide some more details on the non-renewals of the CAT-exposed home business. In which states are your actions primarily taking place? And are there particular years of business that you're focused on? I guess in general, if you can talk about any insights that you've learned from your more recent models that led to your decision. Daniel Schreiber Yes. A couple of thoughts there. In terms of the distribution across states, it's really more of a -- it can be concentrated in states. It's really focused -- tends to be focused more on expected lifetime value which tends to be quite driven by a higher than target loss ratio that tends to be concentrated within the home book almost entirely which is the most challenging loss ratio we have. We've talked a little bit about in the letter the range that we're targeting which is 20 to 25. We talk about a range because it's not a hard number but it's based on what we know and as we're kind of developing that analysis, that feels like the most appropriate range. Important to note that while it puts downward pressure on IFP growth, as all of our -- every customer kind of adds up to that total IFP number, from a cash perspective or a value perspective, it's got a very high ROI. We're taking out much more expected cost than we are taking out contribution from the premium, so it's definitely ROI positive. If you take out, for example, $25 million of IFP with an elevated loss ratio, you can generate, using our own model, something like $50 million or $60 million in net positive value. A little short-term pressure on IFP but over the medium term, long-term value. In terms of timeframe, these tend to be older policies, so our underwriting rules and our AI models get a little bit better every day and so the concentration tends to be business we wrote 2 or 3 or 4 years ago in some cases. And as noted, the vast majority, if not 100% of this business, would be business we wouldn't write today under our current underwriting guidelines. Jack Matten That's helpful. Thank you. The second question is on capital. Can you talk about the premium to surplus ratio that Lemonade expects to maintain as your business mix evolves? And I guess somewhat relatedly, it looks like your invested asset balance has been falling in recent quarters. Is that something that the company expects to continue doing moving forward? I think just trying to get some insights into that investment income. Thank you. Tim Bixby Sure. On the capital surplus, we've not talked about that for a while because things are essentially unchanged. Our target is and continues to be a roughly 1:6 ratio of acquired surplus to gross earned premium. And we've got at least a couple of very effective tools in place to help us drive that number to what is arguably sort of best-in-class in the industry. This is what many insurance companies shoot to do. And I think we're performing quite well on that metric. Our quota share structure, our Cayman captive structure, these are really designed not only to mitigate volatility but more importantly to drive -- to enable significant capital surplus efficiency. That's really unchanged at that 1:6 ratio. From a cash investment standpoint, yes, you will note if you kind of charted out the cash balances has increased somewhat as a percentage of the total. That's not so much a concerted strategy. I would expect that trend to moderate or even flatten out before too long. However, the interest rate environment is what it is. We're expecting what you and others are expecting in the market, that there will be perhaps more downward pressure on interest rates than upward pressure and we factored in sort of the most current forecasts into our guidance in terms of what the expected investment income is likely to be. The good news is, our cash investments balance actually went up this quarter in total. We're earning really strong returns on the cash as well as the investments. And so that's something that I would highlight. We foresee that cash and investments balance basically troughing, might drop another 1% or 2% as we noted but that puts us well above a $900 million total cash investments balance from here on out as far as we can see. Compare that to 3 or 4 years ago when there was quite a bit more uncertainty as to our growth trajectory and where that balance might end up, that's a dramatic change and I think it probably has a tremendous foundation for us going forward. The next question comes from Michael Phillips from Oppenheimer. Michael Phillips A question first on auto and kind of follow-up from the opening comments about new state expansion as you get into next year. The last 10 I had, I think you were in 11 states. I'm not sure that's still right. As you look out over the next maybe 18 months, given kind of the decent rate environment for auto, it might be slowing down. But should we expect state expansion by say yearend '25 to being close to like 20 states or 40 states or just kind of how aggressively you want to be over the next 18 months? Daniel Schreiber No, I don't think we'll be at 40 states. And of course, to state the obvious, not all states are born equal. We will be expanding throughout 2025. We haven't given specific numbers and so my answer today is going to remain a little bit vague still. One of the driving factors is going to be the graduation of renters to be car customers. We will be looking and one of the guiding principles Shai spoke about, regulatory environment and some predictive loss ratios. Another one is where we have the largest footprint of renters who have cars but don't have car insurance with us and that will be another driving force. But we're not ready to disclose numbers of states yet. Michael Phillips Okay, I can appreciate that. Thanks, Daniel. I guess continuing with that, maybe a follow-up on that is, typically, as we're growing in new states, there can be some pressure on our margins in auto. Maybe for you guys, I guess I want to see what -- do you think that might be a bit muted than what normally is the case, given -- I think you've talked about knowledge that you have from your current renters and homeowners customer base and how that can translate into more information in your initial pricing for auto as that starts to grow? Daniel Schreiber Yes. Look, we are -- I sort of mentioned this before but we are very bullish in the medium to long term on car. We think it's a highly differentiated product with a strong and structural competitive advantage given that at first approximation, all our customers use telematics on an ongoing basis. And whereas at first approximation for the incumbent that's none or 0. This is really a very powerful differentiator quite beside or in addition to the fact that we have really spectacular user experience, very high customer satisfaction levels, etcetera. Going back to my comment earlier about the renters aspect here, yes, we are seeing that renters who buy car insurance have a much, to use your words, muted loss ratio, In fact, their whole economics are dramatically different. The cost of acquisition is effectively 0. You might even conceive a bit as being negative cap because our renters book is very profitable. And then you've got existing customers who ostensibly have paid to be Lemonade customers but they are profitable at the outset and then we get to sell them a car policy with no incremental cost. Again, I'm rounding here but I think a price approximation that holds true. And we have found them to be not only highly profitable because of the absence of any customer acquisition cost but much better because we do use the factors that you said, much better risks. We can price them effectively. We don't see the new business penalty that you see when you usually grow a book. So very, very different unit economics and lifetime value of existing customers. This is really, I think, a strategic pillar that we will expand on during our Investor Day as well later in the year. We do have over 2 million existing customers, many of whom have car insurance, just not with Lemonade. And that opportunity translates into a very, very sizable and ultimately we expect, very profitable opportunity for us. Shai Wininger Probably also worth noting that the external environment is improving as well. For some time, we and other car providers were chasing a target with inflation's unfavorable impact on cost of repairs and cost of claims. The data is now really showing that that trend has slowed, if not stalled and in some cases may even reverse. And so, chasing that target is now much -- the impact of our rate increases, both those already in place and those we are continuing to work on, have an even greater impact and that really provides a higher level of confidence comfort in our planning for car for the rest of this year and well into next year as well. We noted that our gross loss ratio improvement across our product lines improved anywhere from 5% to 30%. Car was right at the upper end of that range, so we're seeing lots of great indicators. The next question comes from Tommy McJoynt from Stifel. Tommy Mcjoynt Tim, kind of going back to the first question that you got on the nonrenewal side, you mentioned the $25 million of non-renewed IFP and that's going to be offset by it sounded like I think you said $50 million to $60 million of sort of net positive value. Let's call it $50 million. Sorry, is that saying that the LTV of those policies, instead of being presumably positive when you wrote it, is now being sort of reassessed at negative $50 million? And hence, by not writing, non-renewing that business, it will now be 0? Just kind of help explain sort of what that $50 million to $60 million number that you mentioned actually is. Tim Bixby Yes. In rough strokes, the way you described it is right. If a customer has an expected lifetime value let's say of 3x its acquisition cost which is often typical for us, that means over the course of their lifetime, 2, 3, 4 years depending on the product or more, we expect to generate that incremental cash flow or value. What this says is we expect that lifetime value to be a negative $50 million or $60 million in the case I described for an IF, so think of that ratio as sort of a negative 2:1 ratio. I mean it's really almost entirely driven by the elevated loss ratio. If a customer has an expected 150% loss ratio for example and you carry that customer out for a couple 3 years or more, that's the driver. I think you have the analysis right, it's rough justice but it's notable -- notably positive ROI for those changes. Tommy Mcjoynt Okay, got it. And do you know what the impact on the loss ratio from that sort of $25 million in IFP was in the first half of the year? Or even in absolute dollars, kind of how much sort of operating loss that business generated, contributed? Tim Bixby Hard to really put a precise number on that. I would think of that range of $20 million to $25 million is over the course of the year, the vast majority in Q3 and Q4. It's really a forward-looking number and expected impact. We have started the process. There was a nominal amount in Q2 but I would say it probably rounds to pretty close to 0. It's really a Q3, Q4 and forward expectation, a little more concentrated in Q3 than Q4. Our loss ratio does -- has borne the burden of that business and so it's really notable I think that our loss ratio improved mid-double digits year-on-year with some of that downward pressure. And so all of these changes, not just rate changes, will have a favorable -- continued favorable impact on the loss ratio going forward. Daniel Schreiber And Tommy, maybe I'll just add -- sorry, just one other kind of vantage point of color and Tim mentioned this briefly in his comments, this is really a homeowners focused fix. It's the one part of our business that has had pockets of sustained negative LTV. And in addition to being negative in LTV, there have also been an environment that oftentimes we could not get the rate approval. In theory, any risk can be priced adequately but we don't always find regulators affording us that luxury. This is part of the business where we just were not able to get the approvals and don't expect to in any fashion. Otherwise, we would have been kind of shown more forbearance if we thought it was on the cusp of turning profitable. But in addition to being stubbornly unprofitable, it also tends to concentrate very much in volatile parts of the country. Even some of this business were we to get to long-term average profitability, we've always sought to avoid the most CAT-exposed part of our business -- of the country rather, sorry and we have avoided writing in the most CAT exposed places really since our inception in places where we have still found that the volatility is higher than we want now, knowing what we know. We're also taking this opportunity to non-renew that part of the business. Tim Bixby And maybe just to put a fine point on it based on a couple of questions I've gotten already, I'll answer a question that has not been asked which is, if this number is 25 as we expect it to be, the question might be, would your IFP expectations have been $25 million greater if not for the impact of this? The answer is yes. Yes. Tommy Mcjoynt Okay, got it. Appreciate that color. And then just quickly, you mentioned the expectations for growth spend in 3Q to be $25 million up year-over-year. Did you give a 4Q number? Or do we have the full year kind of expectation? Tim Bixby Yes. I would think of the full year as really unchanged. The timing over the course of the quarters has changed somewhat. The guidance we gave historically is sort of between $100 and $110 million, $105 million is the number we've mentioned. I think we're still sort of on track and planning to spend that rough amount over the course of the full year. We have adjusted the timing of that somewhat a little bit more than initially planned in Q3 than otherwise. Q3 is typically the highest gross spend quarter in any case in most years. And the fourth quarter, obviously, if you kind of do the math, will be somewhat elevated as well. Q1 was really the ramp-up quarter and so it's a pretty steep climb and we expect Q3 to be at the rate we disclosed. The next question comes from Bob Huang from Morgan Stanley. Bob Huang Great. First one is on your 17 points of improvement in CAT losses which was -- I mean, sorry, 17 points of the impact on CAT losses which is a 5-point improvement. Directionally speaking, that's obviously similar to the industry. As you non-renew the homeowner side, is there a run rate expectation on what CAT losses should look like going forward? Can you give us a little bit more color on just like how we should think about that impact? I know that you already talked about quite a bit on the impact on the other side of things on the homeowner renewal. Just to see if there's any additional color on the CAT side. Tim Bixby That's probably a little bit beyond some of the guidance we've given. I can give a little bit of the way you might think about it. Our home business as a share of the total business is coming down as a percentage but just modestly. I think it came in the quarter and this is home and condo combined, came in about just under 20% and it's down a couple of points year-on-year. And so, you can kind of back into -- if we were to take $25 million of IFP out, back into what that impact might be. In terms of the specific reduction on loss ratio, it's a little tricky to do that. I'm not going to venture that far. But CAT is really isolated almost entirely to home, not quite 100% but primarily home. And really, these are the most challenging policies obviously that we'll go after. I'll leave it to you to kind of do some math but that's how I would go about it. Bob Huang Okay. Maybe second one on just how we should think about ceding commission. If we look at a ceding commission as a percent of premium last call it 5 quarters, it's generally about 20%. This quarter was notably lower than that. Is this more of a one-time thing? What's driving that? And should it go back to about 20% of premium going forward? Tim Bixby Yes. A couple of ways to think about the ceding commission. Year-on-year there is a change because there was a change in the structure. The prior year was a fixed structure up through our July renewal a year ago and so you saw in the face of the P&L roughly a 20% effective commission. Now our commission, because of the way we do the accounting, it's split into 2 pieces, so our effective commission rate was about -- running about 23%. But the most important thing was it was static. It was a fixed number. That's now variable. That's helpful in some ways but a little less -- a little trickier when you're building a model. But the net difference over -- I think one way to think about it is to look at Q1 and Q2, the net commission was about 18% versus 20%, so modestly lower but just by a couple of points. But more volatility, more variability, so Q1 was a fair bit lower, Q2 was higher. We'll continue to see that move around a little bit quarter-to-quarter but that gets trued up as you go through the course of the year. I would expect -- we'll give as much of an indication on that as we can but I would think of it as a couple of points lower than prior year but there are some offsets to that as well. Our renewal this year was similar. It is also a sliding scale that begins this month, began in July. But the scale and the expected effective rate will actually be a little bit better. At this point, it's hard to say if it gets back to the prior level but it should be up maybe 1 point or 2 on any sort of apples-to-apples comparison so slightly better terms in this renewal. Probably also -- probably also worth answering another -- I like answering questions that weren't asked, so I'll throw in another one which is, because a loss ratio varies obviously quarter-to-quarter, the typical pattern has been a Q4 loss ratio that's the lowest of the 4 quarters. That's happened often in prior years. We expect it will happen this year. And if that plays out as expected, that has a pretty strong favorable impact on that commission rate. And so again, a little more volatile quarter-to-quarter but if things play out as expected and as historical patterns, you'd see a nice favorable impact over the course of the year. It gets us back on track versus some of the prior quarters. It can be a little bit lower commission rate. Thank you. The next question comes from Matthew O'Neill from FT Partners. Matthew O'Neill I just wanted to ask a little bit about premium per customer. It's been growing impressively but the rate may be decelerating slightly. I was just curious if you could give us an assessment of kind of how far through the rate increases you are on the in-force book? Tim Bixby Yes. That can vary quarter-to-quarter. It has been a pretty steady contributor but our customer count was a stronger contributor to growth this year quarter-on-quarter than the price increase. It varies by product. As I mentioned in car, you're seeing a pretty dramatic impact in rent, much less so because it's really so optimized. The loss ratio is such a strong loss ratio as it is and pricing is quite good. So it varies by product. In terms of where we are, I think 2 or 3 quarters ago we mentioned that we were sort of halfway through. There's $100 million or so remaining to earn in. That's more or less unchanged because as we -- the pace of us earning in rate and the pace of us filing for new rates has been roughly in balance. I think of us in a similar spot now where there's still plenty of rate to earn in. Obviously, that doesn't last forever. There will always be rate filings and always increases even in a low or no inflation environment but we're quite a ways away from that. That is factored into our -- the Q3, Q4 guidance that we'll continue to earn at that pace and it will go into next year. Things that are approved and in place will earn well into next year. Matthew O'Neill Thanks. That's very helpful. And maybe just a quick one and I realize I may be jumping the gun on potential Investor Day content but I know you've spoken about the long-term or ultimate target for the loss ratio in the high 60s to 70s [ph]. I don't know if there's kind of an internal or a way to think about the ultimate target for the expense ratio going forward. Daniel Schreiber We are determined to have an expense load that will be absolutely better than the industry. We're beginning to look less at ratios because we also intend to be a price leader. And that might not give you as clear a picture of just how advantaged we think we're becoming due to our technology but it will reflect itself in I think best-in-class expense ratio and even more dramatically in actual expense load. If you kind of put it on an apples-to-apples basis with the same premium and that's being charged by competitors, it will manifest itself more powerfully still than when you look at it against our own lower premiums because we think we get to pass some of those savings on to our customers and that can accelerate growth, accelerate retention, lower cost of acquisition and allow us to achieve our ultimate and rather ambitious goals for the company. But if I answer your question kind of more straightforwardly, we think that at scale, we will be in the teens. We disclosed last quarter that the LAE component of our expense stack has already achieved parity with the very best in the industry. We reported a 7.6% LAE last quarter. Shai mentioned some of the efficiencies that we're gaining through automation and we're really seeing these rollout very, very powerfully in some of the numbers that we shared earlier about what's happened to our headcount expense, what's happened to our what we're calling IFP per human, how many people were needed to gen -- as we've doubled our book, we've been able to over the course of the last few years, we've been able to halve the ratio of people needed to generate every dollar of premium. We're seeing very dramatic advancements, all of which will ultimately reflect themselves in our competitive expense structure, some of which will manifest as lower prices and some of which will manifest we believe still as best-in-class expense ratio. That said, I'll add to that and there was reference to this in the letter as well, we think of for structural reasons that may be obvious and some that are less than obvious, we think of growth as the gift that keeps on giving. We really think that the number that I just gave and the direction that I just outlined will become -- at the moment, you can look at various numbers in the field in action and I referenced a few of them. I think a few years from now, it will be unmissable. It will be kind of glaringly obvious and the difference between now and then is that will continue to grow. And as we continue to grow, as we've doubled our business while holding our expense structure flat, we kind of shared that over the course of the last few years, we've seen expense net of customer acquisition actually decline even as we've enjoyed record growth. Clearly, that moving forward, holding expenses relatively flat and really start seeing how this generates a very, very profitable business. But that dynamic will continue to manifest with ever greater force as we continue to grow. When we double our business, you will see it with greater clarity. When we 10x our business, as I say, it will be glaringly obvious. Thank you. The next question comes from Yaron Kinar from Jefferies. Unidentified Analyst This is Charlie [ph] on for Yaron. A couple of questions. The first one, with the decision to non-renew certain CAT-exposed homeowners, was that previously contemplated in guidance? Okay, thanks. And then are you guys able to give us CAT prior year development and LAE on a net basis? Tim Bixby The prior period development, you can split into 2 pieces. It was 3 points favorable. It was 2 points unfavorable from a CAT perspective and 5 points favorable from a non-CAT perspective. Netting out to the 3 favorable. Unidentified Analyst Okay. Sorry. And just to clarify, was that gross CAT or net CAT impact? Yes. And then that breakdown would be roughly similar on a net basis, the prior period development. The total CAT impact on a net basis was about 15 points, whereas on a gross basis, it was about 17 points. LAE came in about 8%. It's been 7 point, mid-7s, edged up a little bit but in that sort of 7% to 8% range, by 8% this quarter. Unidentified Analyst Okay, great. And then last one if I could, just looking at the underlying loss ratio, it looks like contemplating those components, you guys saw about 22 points of underlying improvement. But if we look at the first quarter of 24% on a year-over-year basis from first quarter of '23, it looks like it was relatively flat. Is there anything underlying that that you guys could provide some color on? Tim Bixby Pretty distinct quarters. Yes, on a full quarter basis, it was pretty stable. I think that it's really important to look at the year-on-year comparison from a seasonal perspective. And on a trailing 12 months basis obviously continued significant improvement. Any given comparison of quarters, you might see some trends that are interesting but not necessarily indicative of a longer-term trend. Nothing in particular to call out that was distinct between Q1 and Q2. Q2 was a really interesting quarter as it evolved, really significant impacts early in the quarter and really dramatic favorable outcomes by the end of the quarter, netting out to what ended up to be a quarter that was even better, just modestly better than our expectations. The months can be pretty unpredictable but the quarters are a little more predictable. [Operator Instructions] We have a follow-up question from Bob Huang from Morgan Stanley. Bob Huang Maybe just a follow-up on the PYD question. 5 points of favorable on everything else and 2 points unfavorable on the CAT PYD. On the 5 points, can you give us maybe a little bit more color on the geography of those? Like what are those 5 points coming from if possible? Sorry if I missed this a little earlier. Daniel Schreiber We did not. It's a little more concentrated in the pet product but it was distributed across products other than home. The CATs are primarily a home dynamic and the increase was driven by those really significant storms from a year ago and a bit earlier this year that have evolved, continue to evolve. But the underlying favorable development I think is really testament to the non-CAT portion of the business which is really all the product lines other than home. Bob Huang Okay. Basically, CAT was unfavorable and dogs were favorable. Thank you for that, that's very helpful. On the other one, maybe on the LTV to CAC side. I know that you talked about previously, you kind of mentioned LTV to CAC is about 3x, then that would be the ratio. And then I think one thing we're trying to figure out is that if you have these homeowner non-renewals, going forward, does that 3x LTV to CAC equation still holds? How should we think about that renewal impact on the LTV to CAC? Tim Bixby Yes. LTV to CAC is an important metric but it's a forward metric. It's based on a model. It's based on all the information we collect. it improves a little bit every day, every week, every month as we go forward. When we acquired that business, when our models were by definition less sophisticated than today, 2, 3, 4 years ago, we expected those to be profitable customers. As we learn more in our models and our existing customer base and claims activity, invariably a certain portion of the customer base, their expected LTV will change. For newly acquired customers, there is no change, so we expect customers we acquire today and tomorrow to be fully profitable. We've seen a ratio greater than 3:1. 3:1 is a good rule of thumb but we've seen certainly periods where it's 3.5 or 4 or more. There tends to be a little bit more pressure when you spend more. We're spending double today what we spent a year ago and that tends to put downward pressure on LTV to CAC but that's a good thing. And we earn our way in and we develop channels, we expand our spending. And overall, 3:1 is a good metric to think about. I'll add one other comment in that area which I think is helpful which is LTV to CAC is kind of policy by policy focused. And if you look at our spending per net added customer, you might think things got more expensive for us in the quarter. And while that exact math is correct, it's important to look at IFP. Net added IFP, gross added IFP really is what we're acquiring with that tax spend. And by that measure, we were actually more efficient in the second quarter than we were in the year-ago quarter and even in the prior quarter. All around, that number is stable and that's what's enabling us to really say we're very comfortable with growth rates that are accelerating. You started out the year in the low 20s, going into the mid-20s and now we're pushing towards the high 20s growth rate and that's a core driver for them. Daniel Schreiber Maybe I'll talk about a comment of color commentary, Bob, as well. LTV to CAC, you always want it to be as high as possible per customer. But truly, you want to keep growing it until you hit the marginal customer where the LTV equals CAC. In other words, if you could spend $1 and get $1.10 instead of getting $3, that is still marginally good for the business, you're still growing profitable business. And since our LTV calculations take onboard the time value of money that's already factored in at a fairly robust discount rate. While LTV to CAC is 3, that's our average, we have many higher customers than that. We acquired many customers in the double digits of LTV to CAC as well. When we'll stop investing is when we hit the marginal customer who's closer to an LTV to CAC of 1. We take a bit of a margin of safety but conceptually, that is the philosophy. We want every marginally profitable customer, we want them and we will continue to grow using that. We have never deviated from that. We have never tried to acquire customers of a negative LTV. Sometimes, we find this confusing to some investors because in the short term, they do customer acquisition can impact our financials negatively in the short term. The year in which you spend that CAC, because we are not an agent-based business and we pay all -- we take all our pain upfront, we earn it back over time. Therefore, when we grow, sometimes it can appear to be a near-term loss but that is just the nature of the flow of time. Fundamentally, it's about spending $1 now and getting $3 back in today's terms. And if that means that in the near term, we take a hit to our EBITDA, we're okay with that. We don't take a hit to our cash because we've got a synthetic agent program in place, so we've neutralized the trough in terms of the cash, in terms of EBITDA. Those things will work their way out during the course of the lifetime of the customer. At any rate, because of that, we have always sought to grow customers on an LTV to CAC basis, never acquiring knowingly negative LTV business. Over the course of the last couple of years with inflationary pressures and others, larger swaths of the nation and of our portfolio were hard to grow in an LTV positive environment and we've spoken about that and we slowed our growth which we're now reaccelerating. And much of those segments of our business have become profitable over time as we got to adequacy and we've spoken about this, we were able to recover them back to where we thought they would be all along. What we're talking about today for the first time is that in addition to being conservative and careful and never knowingly writing negative business and proactively working to bring back into profitability any business that fell out of it and largely succeeding, we're also not tolerating business that has fallen between the cracks and we've not been able to bring back to profitability. Not only are we not writing knowingly unprofitable business, as we never have, we are now not renewing such business either, having in some places, exhausted in the near term what rate can deliver. And therefore, the philosophy is the same philosophy, the profitability focus of the business has been the same consistently. But now actually not really slowing down in places that aren't profitable but even potentially going into reverse markets that don't contribute. And Tim's earlier comment that, yes, you may see a hit, a potential hit of $25 million to IFP, we're reiterated guidance. We think we're going to manage that within the guidance already given. We think that we're overdelivering for the year and we have that spare to be able to hit guidance notwithstanding this. You won't see a hit to the IFP but it could have been much higher, as Tim said. But we've always been focused not mainly on growing IFP but in growing the total value of the book and this really as a boon to that, as Tim said, $50 million, $60 million of LTV added to our business because of this decision. Thank you. That was our final question for today. So this does conclude today's call. Thank you all for joining. You may now disconnect your lines.

Intact Financial Corporation (IFCZF) Q2 2024 Earnings Call Transcript

Intact Financial Corporation (OTCPK:IFCZF) Q2 2024 Earnings Call July 31, 2024 11:00 AM ET Company Participants Kevin Lemay - Deputy Senior Vice President and Head, Financial Performance Charles Brindamour - Chief Executive Officer Louis Marcotte - Chief Financial Officer Patrick Barbeau - Chief Operating Officer Darren Godfrey - Executive Vice President and Chief Underwriting Officer, Global Specialty Lines Gui Lamy - Senior Vice President, Personal Lines Ken Anderson - Executive Vice President and Chief Financial Officer, UK&I Conference Call Participants Paul Holden - CIBC Tom MacKinnon - BMO Doug Young - Desjardins Capital Markets Mario Mendonca - TD Cowen Grace Carter - Bank of America Jaeme Gloyn - National Bank Financial Lemar Persaud - Cormark John Aiken - Jefferies Nigel D'Souza - Veritas Operator Good morning, ladies and gentlemen, and welcome to the Intact Financial Corporation Q2 2024 Results Conference Call. [Operator Instructions] This call is being recorded on July 31, 2024. I would now like to turn the conference over to Kevin Lemay, Deputy Senior Vice President and Head of Financial Performance. Please go ahead. Kevin Lemay Thank you, Lily. Good morning, everyone, and thank you for joining the call to discuss our second quarter financial results. A link to our live webcast and materials for this call, have been posted on our website at intactfc.com under the Investor tab. Before we start, please refer to Slide 2 for a disclaimer regarding the use of forward-looking statements, which form part of this morning's remarks. And Slide 3 for a note on how to use of non-GAAP financial measures and on terms used in this presentation. To discuss our results today, I have with me our CEO, Charles Brindamour; our CFO, Louis Marcotte; Patrick Barbeau, Chief Operating Officer; Darren Godfrey, Executive Vice President and Chief Underwriting Officer for Global Specialty Lines; Gui Lamy, Senior Vice President, Personal Lines; and Ken Anderson, Executive Vice President and CFO, UK&I. We will begin with prepared remarks followed by Q&A. With that, I will turn the call over to Charles. Charles Brindamour Good morning, everyone. Thank you for joining us today. I want to take a minute to acknowledge the extreme weather events across Canada over the last few weeks. These are tough times with the loss of homes, the destruction of businesses and stressful evacuations. We are focused on providing support to customers in a time of need. Maintenance teams, on-site and wildfire defense systems have been really quick to respond. We are proactively contacting customers to assess their situation, providing funding for additional living expenses and are present on the ground where possible to begin rebuilding efforts. It's in these moments that we're reminded of how important our purpose is. That's to help people, businesses and society, prosper in good times and be resilient in bad times. As for our second quarter results, yesterday evening, we announced net operating income per share of $4.86, which doubled since last year. This was on the back of strong underwriting performance in all lines of business, as well as solid growth in distribution and investment income. Top line momentum is strong at 6%, led by double-digit growth in personal lines. And while the margin and commercial lines is changing, it remains favorable, and we expect the industry growth to be at least mid-single digits for the next 12 months. As such, we're quite positive about our own growth outlook. Our combined ratio was excellent at 87.1%, 9 points better than last year. This reflected a 2-point improvement in our underlying performance driven by growth in the most profitable segments and favorable market conditions. Catastrophe losses were also low for the second quarter, in contrast to the severe weather events reported last year. Overall, with our operations performing really well, operating ROE stood at 17%, up 4 points year-over-year. And we maintain our balance sheet in a position of strength with an increased $2.9 billion of total capital margin and leverage in line with our 20% target. Now let me provide some color on the results and outlook by line of business, starting with Canada. So in personal auto, premiums grew 11% in the quarter, up 5 points from a year ago. Top line momentum reflected both rate increases and customer growth. The industry continues to face profitability challenges and is pursuing corrective measures. As such, we expect hard market conditions to prevail over the next 12 months and industry growth to be in the double-digits. This environment plays to our strength given early action, advanced segmentation and deep supply chains. Our brand, distribution and digital leadership help us grow in this tough environment. And the combined ratio in auto was solid at 91.4% in a seasonally favorable quarter. Underlying performance was strong, improving 3 points year-over-year, which offset lower favorable prior year development. As a result, we remain comfortable with our sub-95 guidance for this business in '24. Moving now to personal property in Canada. Premium growth was 9% in the quarter, driven by our rate actions and continued customer growth. We expect the current hard market conditions to persist over the next 12 months, and industry growth could reach double-digits. Combined ratio is very strong at 78%, with low cat losses in a typically active season. Underlying performance was robust, improving 9 points year-over-year, as we reacted promptly to early signs of severity pressures last year at heavy cat losses. In commercial lines, premium growth was 1% in the quarter with a very strong combined ratio of 83.6%. Rate increases were healthy and in the mid-single digits. This was though mainly offset by increased competition for large accounts, which was evident in Q1 and continued through Q2. Given our focus in the mid-market space, we're really keen to grow in this environment that means to do so. Moving now to our UK&I business. Premium growth was 42% in the quarter, mainly due to the Direct Line transaction. Organic growth was 6%, driven by rate actions and solid new business. The combined ratio was healthy at 92.2% in line with our expectations as we take cautious stance on the recently acquired Direct Line business. Integration is progressing well as we've begun the migration of customers to the RSA platform. Going forward, we're well positioned to deliver a sustainably low 90s performance in this business. In the U.S., our premiums grew 1% in the quarter. Our strategy is very segmented. Growth in our most profitable lines is strong, while corrective actions are being applied on underperforming segments. The environment remains favorable, though and even across lines, and still provides good growth opportunities. The combined ratio was solid at 88.5% in the quarter, and the business remains well positioned to maintain a low 90s or better performance. Our team continues to execute with rigor and discipline against our strategic priorities. Let me highlight important milestones and initiatives delivered over the past few months. In Canada, BrokerLink further consolidated the market, successfully closing 9 acquisitions this quarter and has now reached $4 billion in annual premiums. The business is well on track to achieve its ambition of $5 billion in annual premiums by 2025. Ongoing investments on the digital and branding front have enabled better direct and Intact Insurance to capitalize on increased shopping traffic with a 39% increase in our web influence quotes this year. This led to strong growth, especially in our direct distribution business, which grew by double-digits in the quarter. The expertise in data and AI that we've built over the years in personal lines than in regular commercial lines is now being leveraged within specialty lines. NS models for property coverages in the U.S. are now being deployed. While our global specialty lines performance is already really good. There remains, in my view, a lot of room to improve from a sophistication point of view. We continue to invest in our supply chain capabilities as well, a key driver of our underwriting outperformance. 5 new claims service centers were opened in Q2, bringing the total to 37 locations across Canada. On the climate front, recent events have shown that we need to double down on our climate adaptation efforts. Since 2010, we've engaged with cities in Canada from coast to coast by providing funding of over $25 million to more than 100 climate adaptation projects. These are focused on helping communities become more resilient. And we're providing an additional $2 million in our municipal grants program to help communities adapt to extreme weather events. June 1 this year marked the 3-year anniversary of the RSA acquisition, a landmark transaction for us, both strategically and financially, with both IRR and net operating income per share accretion above 20%. And looking forward, the platform we've built is impressive with a meaningfully larger and more resilient footprint. We've become a global specialty lines leader with more than $6 billion of premiums worldwide. We also now have a new pipeline of growth in the UK, which is on the path to delivering mid-teens operating ROE. And we have substantially expanded our scale advantage in Canada, where we're more than twice the size of number two in a highly fragmented market. With an overall ROE in the high teens and a balance sheet and a position of strength, we're very well positioned to invest and grow and achieve our financial objectives in the years ahead. And with that, I'll turn the call over to our CFO, Louis Marcotte. Louis Marcotte Thanks, Charles, and good morning, everyone. This quarter is a further proof point that our strategic actions in recent years and our focus on outperformance is paying off. Strong underwriting performance as well as robust investment in distribution income growth, have all contributed to an operating return on equity of 17%. It is worth noting that this return still includes the impact of the $600 million of catastrophe losses from Q3 last year. Catastrophe losses totaled $96 million this quarter, Q2, and reached $193 million for the first half of 2024. While this is below expectations, we still have 6 months to go into '24. We had the recent floods in Toronto, and we are also monitoring the impact of the forest fires in Jasper, Alberta. Although we expect significant losses from these two events, we remain comfortable with our guidance of $900 million on an annual basis. Favorable prior year development of 4.7% was in line with last year and remained at the higher end of our guidance of 2% to 4% overall. This was driven by healthy development across all lines of business, reflecting our prudent approach to reserving as well as favorable development on the elevated catastrophe losses from last year. The consolidated expense ratio of 34.1% in the quarter was in line with prior year, and while there are some movements by quarter, we continue to expect the full year ratio to land within the range of 33% to 34%. Operating net investment income increased by 19% to $387 million in the quarter, driven by higher reinvestment yields captured in the latter half of 2023. Given persisting high short-term yields, we expect investment income to be north of $1.5 billion in 2024. Distribution income was $169 million in the quarter, an increase of 23% versus last year on the back of higher revenues from solid organic growth and robust M&A activities in the latter part of '23. With this growth momentum, led by our wholly owned distributor BrokerLink and a healthy pipeline for acquisitions. Distribution income remains on course to deliver growth of at least 10% in 2024. Our operating effective tax rate was lower than expected at 19.5% in the quarter. This reflected the impact of new Canadian tax legislations recently enacted, offset by tax recoveries related to the increasing profitability in our UK operations. Looking ahead, we expect our operating effective tax rate to be around 22% to 23%. Overall, net operating income per share grew 108% in the quarter, a third of which was attributable to strong underlying performance in all geographies as well as stronger investment and distribution results, the remainder from lower cap losses. Earnings per share growth was also robust, thanks to the strength of our operating earnings, but also due to improving non-operating results, including muted exited line losses. This contributed to a book value per share growth of 4% in the quarter and 15% year-over-year to $88. Over the past 5 and 10 years, our book value grew 12% and 9%, respectively, on an annualized basis before adding the impact of dividend yields. This is very consistent with our NOIPS growth of 12% over the past decade, and our average ROE outperformance of 6.8 points over the same period. In my perspective, this track record is industry-leading and we intend to maintain it going forward. Our balance sheet continues to strengthen, thanks to approximately $1.4 billion of capital generated year-to-date, leading to a total capital margin of $2.9 billion at the end of June. Some of the capital generated was used for deleveraging and drove our adjusted debt to total capital ratio down to 19.8%. Overall, our balance sheet is as strong as ever, and our capital generation capabilities provide flexibility to invest in growth, both organically and via acquisitions. Overall, I'm proud of the strength demonstrated by the business again this quarter. With the platform we have in place, the quality of talent we have across the globe and a clear strategic road map, we are in very good shape to grow net operating income per share by 10% for years to come and outperformed the industry ROE by at least 500 basis points. I would like to thank all the teams that are there for those who have been impacted by the recent weather events across Canada. We've been on the front lines of climate change for over a decade. And with the strength of our people, we continue to help protect what matters most to customers and building a more resilient society. With that, I'll give it back to Kevin. Kevin Lemay Thank you, Louis. In order to give everyone a chance to participate in the Q&A, we would ask you to limit yourself to 2 questions per person. You can certainly re-queue for follow-ups, and we'll do our best to accommodate if there is time at the end. So Julie, we're ready to take questions now. Question-and-Answer Session Operator Thank you. [Operator Instructions] Your first question comes from Paul Holden from CIBC. Please go ahead. Paul Holden Thank you. Good morning. First question is related to personal auto. I'm getting a lot of questions on how sustainable this high level of premium growth might be as we go into '25. So I guess my first question on that is maybe you can provide some context in terms of auto rate approvals you received year-to-date? And then maybe also in terms of like the or less regulated markets you operate in where premium growth is trending as well, just to get a better sense of sustainability on that strong top line numbers you're posting. Thank you. Charles Brindamour Thanks, Paul. We'll ask Guillaume to share his perspective. Gui Lamy Thanks, Paul. So first, I'd like to point out industry is still not in a profitable position in personal auto. We've seen in 2023 as well as in the first quarter of 2024 combined ratio of - north of 100% for the industry. On our side, we were writing rates in the low-double digits right now. And with the rate approval that we have already obtained, we're expecting to stay at the current rate level for the remainder of the year with some residual flowing into 2025. Beyond that, it will really depend on how the loss trends evolve in the upcoming quarters. There is an obvious downward trend observed especially on physical damage coverage's, but we're keeping a close eye on the liability trends. So we'll adapt our strategy in each province is based on the local outlook, on trends and inflation. And nationally, we're already rate adequate and outside of Alberta, we're in a good position to execute on rates, where we need them and when we did them. Charles Brindamour Great. Thank you very much, Guillaume. So Paul, when you ask yourself how much time, the way the math probably works here is that you have an industry in aggregate, that's operating above 100% combined ratio. So that tells you that there's a rate adequacy problem at the industry level. Now the challenge is not just to bridge that gap. The challenge is also to cope with the mid-single-digit inflation that is currently in the system and prospectively. So for me, it's easy to see that you've got 12 months worth of correction at least, I think, in the market. So this plays to our strength because we moved really fast and we're keen to grow in this environment in most jurisdictions. Paul Holden Okay. Thank you for that. That's helpful. And then second question for me and this is maybe a little bit more of a nuanced one, but I see that you expect to increase investment allocation to common equity by roughly 4 percentage points by end of the year. So my question on this, is this a move to enhance net investment income or is this more of a move to offset the anticipated downward pressure on short-term fixed income yields? Charles Brindamour None of the above, but I'll let Louis share his perspective. Louis Marcotte No, Paul, you may have noticed, I will say probably over 3 years, we've been underweight on equities compared to our historical position, and for good reason, market volatility, but also in the midst of the RSA acquisition following the COVID crises, we were sort of very prudent. And now we're at the point where capital is reestablished, balance sheet is strong, and we feel conditions are right to move back towards our targeted allocation, which is the 4 points you've raised earlier. This is what we view as per our efficient frontier work as being the optimal way to allocate our assets and therefore, it's a return based on long-term return expectations, not on the short-term basis. So it should not come as a total surprise. We were there before we're going back. We think the time is right now. And the reality is you might come back with the forecasted investment income with short-term rates being where they are, the gap between the long-term equity returns and those rates are not huge. But over the long-term, we think that, that will drive actually ROE outperformance points based on historical experience with our asset allocation. Paul Holden Okay. That's helpful. Charles Brindamour We were playing defense a few years back, anticipating the pension buy-in and acquisition in the UK, a bit of volatility. Now we're moving back to target. Paul Holden Got it. Thanks for that. Operator Your next question comes from Tom MacKinnon from BMO. Please go ahead. Tom MacKinnon Yes, thanks very much. First question, I guess, is there anything else you can add with respect to potential losses associated with the Toronto floods and the Jasper fires, other than this adhering to the $900 million annual cap loss guide. Charles Brindamour So why don't we ask Patrick to share his perspective on what's going on at the moment that's all hands-on deck, that's our business, and Patrick will give you a bit of perspective. Patrick Barbeau Right. So the last flood in Toronto from 2 weeks ago was really the first significant weather events we had this year. So our operations were ready to jump in. They were pretty quick to respond both the claims operations and the onsite teams. We now have a pretty good view on the volume of claims and a lot of the work, the emergency work is done, but we are at the early stage of the rebuild process. It's very interesting for me to see that three quarters of all the files in the Toronto area are being indulged by on-site, which is by far, the most files they've taken on any single event since we acquired them a few years ago. On the Jasper side, this one is more recent, thanks to WDS war on the ground, we received some information. We have also other sources of mapping and inventory that helps us have a reasonably good understanding of the extent of the damage, but our teams, our underwriting - our adjusting teams don't have direct access to the site as we speak. We've been proactively contacting our clients from the area to offer help in their temporary relocation process. And to give you a feel, we insure about 700 families and businesses in the area that have been evacuated, and we estimate that around 250 or so have very likely suffered significant damage. At this point, though, when we look at our estimates of these two events like Charles mentioned, or we and the low amounts that we've incurred in the first half of the year, our total year guidance of $900 million is still a good number at the moment. Charles Brindamour Thanks, Patrick. I think for us, true estimates at this stage. When you think about our retention per event, $250 million roughly, in those events, we're meaningfully above that, that would be easy for us to put a number on the table, they're not. And therefore, we want to get a bit more maturity on both these events at this stage and all the energy is going to getting customers back on track as opposed to filling around with models. Tom MacKinnon Okay. Thanks. And on the on-site, where does that show up in terms of your earnings? Which one of the lines would we be looking for in terms of your ownership of the earnings with respect to on-site? Louis Marcotte So the - our share of their earnings, which is 100% is in the distribution income and other. Tom MacKinnon Okay, great. And so then the second question has to do with the favorable development we continue to get. That's kind of running north of your 2% to 4% guide, what can you attribute that to? What kind of - what accident years, what lines are you seeing the most favorable development? And if I look in 2023, you had unfavorable development in personal property. You said that was atypical. If you can just elaborate on why that may have been atypical and why we wouldn't expect that going forward? Thanks. Louis Marcotte Sure. So maybe I can start with some color here. So 4.7% versus our guidance of 2% to 4%, I will say there's probably close to a point that comes from prior year cats, and that should not be a surprise with the level of cat activity we had seen last year, you would expect some favorable development given the way we reserve for the cat activity to come back in the following year. And of course, it's outsized given the level of cats we had in the prior year. I would say, secondly, I think the - we've talked about prudence for a long time. And you're seeing some of it come back. We're getting further away from the famous COVID years. So that's - you see it in auto, it's still very positive, but tempering, which is as expected. When you talk about personal prop, last year was an exception. If I recall correctly, we had a late year storm, which we had some unfavorable development in the first half of the year. But if you look back a number of years, it's pretty unusual for us to see that, what the reality is we reserve to make sure we never see it in PYD. In this case, it was a late storms that surprised us in the first half of the year. That's why we say it's unusual, and we expect to go back to within the ranges, I will say it varies by line of business by quarter a bit. But overall, you should expect us to land roughly within that 2% to 4%. And I would say largely across lines of business. It won't be even over time - over quarters, but over time, it should be landing in those zones. Tom MacKinnon Okay, thanks. Operator Your next question comes from Doug Young from Desjardins Capital Markets. Please go ahead. Doug Young Hi, good morning. Hi, Charles. On Canadian commercial, looks like competitive pressures in the large case has persisted for, I guess, two quarters in a row. And I'm just hoping you can flesh out just what you're seeing. Can you remind us how much of your Canadian commercial is large case versus mid case where you're trying to grow? And are you seeing this move into other segments of the commercial market. Are you starting to see some irrational behavior anywhere across the Canadian commercial landscape. Charles Brindamour Doug thanks for your question. In aggregate, no, I'll let Darren share his perspective on what we're seeing in Canada. Darren Godfrey Yes. So thanks for that, Doug. A number of moving pieces that I'd probably want to highlight in the quarter, but firstly, I mean, as we said in the remarks, rates are in that sort of mid-single-digit range, quotes a new business were both up in the quarter year-over-year. So that's positive. As we highlighted, we did see some pressure in the large account space. That is about 10% of our total Canadian commercial lines' portfolio. And I should highlight that Q2 in particular is our largest quarter from a large account renewal standpoint. So obviously, we saw the effect more in Q2 here. We had a number of other pieces of, say, timing related with movement of renewals from quarter-to-quarter that had about a point of an impact. And as we mentioned last quarter, we continue to take action on unprofitable accounts, and that was worth about a point as well. So even though there was all that noise in the quarter, retention was still relatively flat, but the biggest driver in the quarter was really around a 3 to 4-point negative mix impact on the top line. Now we'll often see that in terms of - I mean, obviously, large accounts is one example of that, but we sometimes will see that. But that, for me, I think, was the biggest driver. It's not something we see consistently every single quarter or quarter-on-quarter. So I think Q2 is more of an anomaly from that standpoint. We like where we're positioned. Rate is still strong. It's a good operating environment. We want to grow here. So I think that's some of the color that I would give on Q2 in and of itself. Doug Young And can you flesh out what you mean by sort of a negative mix? Can you just kind of elaborate on that? Charles Brindamour Yes. The math goes like this. You have retention for SME, retention for mid-market, retention for large account, when your retention for large account is meaningfully lower than the average retention across the rest of the book, you get a mix change, so to speak. Not much to do with profitability. In fact, the profitability is strong across the board. It's just the average size of account written in the quarter has created a drag of 3 to 4 points as Darren just highlighted. Doug Young Got it. And so you're still seeing price increases in the large case, Darren. Like is that - and is that - just you're not seeing a market as hard as it once was? And it doesn't sound like there's any irrational behavior going on, but - yes. Darren Godfrey I mean in that large account space, it's case price underwriting. So some are up, some are down. It's a function of the individual accounts. Charles Brindamour Yes. Doug Young Okay. And then the second question is just something that I'll throw out there. I'm not sure it's relevant or not. But obviously, we had the CrowdStrike outage. And just curious what implications that has on your business from a business interruption perspective, I know you - I think you've been starting to right cyber policies. Maybe kind of how does that impact you from a current business perspective, but even kind of framing your view in terms of the outlook for building out that side of your business? Charles Brindamour Yes. I'll ask Patrick to share his perspective. Patrick Barbeau Yes. So first of all, on the commercial base product business interruption, this kind of outage from system is not covered. If it's similar to the COVID business interruption, it requires physical damage to trigger business interruption. Clearly in this case, this is not the case. We do - there is some coverage on our cyber insurance policy for this. But for the large majority of these products, there is a time - waiting time period, financial deductibles and then for excess policies, fairly high attachment points. So we don't expect any significant costs from these events. We have received a few claims that we're investigating, but overall, it won't be significant. Charles Brindamour Most people were back on track in a short period of time. Patrick Barbeau Yes. They need the same day. Doug Young Perfect. Thank you. Operator Your next question comes from Mario Mendonca from TD. Please go ahead. Mario Mendonca Good morning. I want to go to U.S. specialty, specifically the comments around certain business lines or segments that require corrective action. Could you speak to the areas where you figure you need corrective action with what's going on there and how important are those segments to Intact? Charles Brindamour Darren, why don't you share your perspective? Darren Godfrey Thanks, Mario. I mean this at a high level, new business was up in the quarter year-over-year, but retention was down 2 points. And that was mostly the result of our own actions. So, business units that I would highlight is entertainment and financial lines. Both were down double digits in the quarter, that was driven a combination of reunderwriting the portfolios, shifting of appetite, I think about our financial institutions' portfolio, but also where we've been pushing strong aggressive rates with the aim to improve profitability. If I was to strip out those actions and those business units, our growth profile in the U.S. in the quarter is more in the mid- to high single-digit range. Now similar to Canada, when we talked about a negative mix, we had 3 points of negative mix in the quarter in the U.S., and that was driven by one single large account in our accident and health portfolio, which is really a downsizing of the transportation account. So again, not something that we would see every single quarter, but that clearly had a significant impact on the top line growth in the quarter. We now strip out two lines, which obviously we're working on remediating. We have very, very strong growth in our strongest performing possible lines. It's a continuation of what we're seeing over the last sort of 12 to 18 months, and I expect that to continue moving forward as well, too. So again, a little bit of noise. Most of it was self-inflicted I would suggest there, Mario. But the outlook remains strong with rates in that mid-single-digit range. We're really looking to grow in that particular marketplace at the moment. Mario Mendonca And those lines, entertainment and financial lines like - yes, financial lines, I think you said, how relevant are those two into that business, particularly in the U.S. Charles Brindamour Well, they're relevant. I mean they're part of the 12 verticals that we believe in and want to grow. And I think in those two segments we want to make sure that they're on the right footing to grow. So I would say they're not the largest lines by any stretch, but there are lines that I wanted to make sure we have respectable, profitable path going forward. And I do believe that these are lines that will grow back in time. Mario Mendonca And then just maybe very broadly, what is the company's outlook for U.S. specialty? Just broadly, is this business, do you still feel like it's a firm market? Is there any change in your sentiment in that business line? Charles Brindamour We love the specialty lines business in the U.S. And if I go macro for a moment, Mario, specialty lines performs better than commercial lines in the U.S., which performs better than personal lines in the U.S. So I feel that entering in the U.S. or operating in the U.S. in really the most profitable segment of the marketplace is the right entry point for us. We've been at it for almost 8 years now. This business in Q1 was outperforming its peers by 5.5 points of combined ratio outperformance. And with the growth pattern that very much looks like our peer set. Now what is the competitive environment at the moment, I would say it is a very good competitive environment. Just to put things in perspective, Mario, in Q2, the average rate increase in the U.S. was 4%. The difference between Q2 this year and Q2 last year where we were closer to 5.5% is that there are a few lines that have softened. And we've talked about those line management liability would be a good example. Cyber would be a good example. And as a result, in these two lines, we're not seeing the sort of growth we have seen as rates were harder in the past 4 or 5 years. But this is still an excellent environment and, frankly, one in which we want to see more growth. Operator Your next question comes from Grace Carter from Bank of America. Please go ahead. Grace Carter Hi, everyone. I wanted to go back to the earlier question about the premium growth in personal auto. And I guess kind of personal lines more broadly. How should we think about the policy count growth component of the top line over the next several quarters? It seems like it's inflected to sequential growth in the past couple of quarters. And I was just curious what you're seeing from a shopping perspective, if there's any updates there and if we should expect maybe acceleration in the policy count growth, and I guess, just kind of to round it out, if given, I think, some of the profitability actions you've been taking in property lines after the cats last year, if we should expect to grow a gap in personal auto policy count growth versus personal property growth. Thanks. Charles Brindamour Yes. Thanks, Grace. We'll ask Gui to give a perspective on what we're seeing from a shopping point of view, what we're seeing in the digital channels and how that should translate into customer growth over time. Gui Lamy Thanks. So we're very comfortable with our profitability position in both personal auto and personal property and are really happy to be growing in that environment. I think the growth was strong again in Q2, 11% in personal auto, 9%ish in personal property. While the unit growth was mildly positive, and as we're still continuing to be active on rates to reflect the emerging trends that we're seeing in the portfolio. We're seeing strong growth in our digital channel. Sales are up 84% year-to-date, which benefits mostly our direct channel, where a larger portion of the traffic is digital. The direct channel also benefited from the conversion of the RSA portfolio, the affinity portfolio to the belairdirect brand, which can now access all the same digital ecosystem as the rest of the retail portfolio. Through time, we're still expecting our profitable - our competitive position to improve as given what we mentioned earlier that the industry profitability is north of a 100%. There's still a fair bit of catch-up to do for the industry, and that should help unit growth going forward, while our retention remains really strong in most markets. So we're already seeing customer growth when we look at written. Written is kind of a leading indicator of the policy in force. So we're expecting that to also become positive. And it's already actually became positive this quarter, and we're expecting that to trend positive for the next few quarters. Charles Brindamour And Grace, we're tactically adding to our marketing or call this response generation sort of budget in the jurisdictions, where it makes most sense to do so because we want to lean in this environment. I'd say the exception here for me remains Alberta, where there's this artificial cap that is below inflation. It's very hard for the industry. And as a result, players, as anticipated, started to exit this market. I do think that if the cat stays in place, you'll see more exit from the market. And every month, where you're in a position where there's more inflation than the cat, our own appetite in this province is reducing, I would say, at a pretty good speed at this stage. We think there are very clear solutions on the table. We've shared those with the government the ball is in their court. Grace Carter Thank you. And sticking with personal auto, I mean, I think the last time we saw such strong year-over-year improvement in the underlying combined ratio kind of on a natural basis was maybe in 2019, but that trend, obviously, it got a bit disrupted by the pandemic environment. And I was just kind of wondering, given the slowing reserve releases in that line, if you could help us think about maybe kind of the long-term target range for the underlying combined ratio in personal auto. And if we should expect sub-95 on a total combined ratio basis to be achievable over the course of the personal auto cycle just kind of regardless of the environment. Thank you. Charles Brindamour Gui, do you want to share your perspective. Gui Lamy Yes. So combined ratio was, again, really strong this quarter at 91.4%. Let's not forget this is a seasonally favorable quarter. So, this is really in line with our guidance of sub-95. We are observing the underlying loss ratio improvement up 3 points with still LT PYD of 3.3 points, which is lower than last year's level. On the cost side, we are seeing inflation in the mid-single digit, very similar to the last few quarters. While on the premium side, both our written and earned rates are hovering around 10%. So, really, our profitability outlook remains unchanged. I think the inflation trajectory is definitely downward especially on physical damage. But we are not banking on a much larger decrease and we are keeping an eye on the liability trends. So, that's why we don't want to really decrease guidance at this point, but we very much like to beat that guidance. So, overall, we are comfortable with our position in personal auto and really happy to be growing in that environment. Grace Carter Thank you. Operator Your next question comes from Jaeme Gloyn from National Bank Financial. Please go ahead. Jaeme Gloyn Yes. Thank you. First question just on capital, the margin, I believe disclosed that $2.9 billion. Louis, can you give us a sense as to how much of that you would describe as excess or deployable capital? And then is there any constraints on the mobility of that capital across jurisdictions? Louis Marcotte So, I would say on the deployable of that margin, I would figure 10% to 15% is probably the pure deployable. It's high because of the capital generation in the first half. There are a few uses expected in the second half now. As you know, we have - redeem preferred shares out of our UK business, and these were closing in July, and so that will consume a bit. So, that's one element and the re-risking of the equity portfolio will be another consumption of capital. So, I expect to level down a bit by - before the end of the year on that basis. And then hopefully, next year, we will start generating a fair bit as well. But I - the deployable, I would peg it in the 10% to 15% range. And then across geographies, it depends on the calendar structure, specifically, generally speaking, what we need to do is pull it out and bring it up to the corporate, and then having the ability to deploy it wherever we want from that point of view. But I would say, given the strength of our capital position in each of the countries, the ability to pull out dividends is quite high. Charles Brindamour Yes. No, I think it is indeed the case. And I think one thing to keep in mind is that, in particular in the UK, each time we improved the earnings profile of the organization vis-à-vis the age capital requirements. And this is good for capital requirement. And so we have made a lot of progress there. You think of the pension buy-in. You think of the improvement, the refocusing of the footprint towards commercial lines. Maybe Ken, you can give us perspective on profitability in the UK and the trajectory that we should expect. Ken Anderson Sure. Yes, look, firstly, things are going very well. Q2 combined ratio, nice 2Q, very solid, in line with the overall 2024 goal of 90% [ph]. And the DLG business, as you know, we have begun reporting that in Q4 last year in the form of a code share. We have been taking a cautious stance though as we assume and integrate that new portfolio. That brings a little bit of a drag on the near-term performance, but very much in line with expectations. And the integrations in full swing though now, policies are now actually renewing onto our platform, gives us much better insight into the portfolio, which is by the way, is 20% larger than what we anticipated and we are getting strong rate on that portfolio, which will bring loss ratio benefit in the coming quarters, and we are on track to realize the GBP20 million of synergies over 36 months. So, if you go back to when we announced the DLG acquisition in Q3 last year, we said that we expected the UK&I business to run in the 92% or low 90% range in '24, but down close to 90% by 2026. We are right on track to deliver that, that's getting us in the zone to mid and above mid-teens ROE in the UK business, and that starts to create room for dividends and capital repatriation from the UK. Charles Brindamour Especially that capital requirements come down when your forward profitability is improving. And so this is really a double impact here in terms of generating strong ROE in that jurisdiction. Louis Marcotte And we get more tax recoveries. Charles Brindamour And we get more tax recoveries. Louis Marcotte It's all positive. Thanks Jaeme. Jaeme Gloyn Great. Operator Your next question comes from Lemar Persaud from Cormark. Please go ahead. Lemar Persaud Yes. Thanks. So, it's meaningful to me that you guys are reminding us that the 17% ROE includes elevated cats from Q3 last year. Is that to suggest that you guys feel like a 17% ROE feels like something that Intact could deliver in a normalized environment? Is that kind of the point to that comment or I might have reading too much into it? Louis Marcotte I would say you are reading is exactly right. That's, we wanted to highlight the fact that the 17% here was not driven by lower cat losses in the quarter. It is impacted - it still is impacted by last year's heavy cat losses in Q3, as we are giving a figure on the last 12 months basis. I think we are running at a very solid 17% right now. And I think our view is with every measure we have in place, this is sustainable. Charles Brindamour Yes, I think the focus for me, when you get past 15%, its earnings growth. And so you need to find that right balance between your growth profile, which translates into earnings growth. And I think that the earnings growth profile of the firm is really good with our new footprint. And where above 15% should you be, in my mind, should be determined by the balance between growth and bottom line translating into earnings growth. Lemar Persaud That's helpful. Now, does it feel like all these positive underlying trends with Intact, like, at what point do you revisit that 500 basis point ROE gap versus the industry? Because it seems to me like you are putting some distance between yourself and peers and maybe that has to be revisited. So, maybe Charles or Louis, at what point do you revisit that 500 basis point ROE gap, and say, this is a large enough organization, we have done enough to improve profitability, and now we think the gap is something higher, maybe 750 basis points. How do you think about that? Charles Brindamour Yes. I think it's a great question, and it's a question we debate from time-to-time. We think the machine can generate more than 500 basis points. In fact, our track record over 10%, 15%, 5%, whatever you want to cut it, it's closer to 600 basis points, 700 basis points. But creating outperformance on a sustainable basis, day-in, day-out has to be achieved at the customer level enough way. And we know in Canada, given our size advantage and the fact that we have been focused for decades on creating outperformance. We know it's super well anchored. We are really happy with the progress we have made outside of Canada, but we have gone from 100% Canadian business 8 years ago and now at 65% Canadian. So, we feel this is still very much the right objective. We have the horsepower to outperform that objective. But we need to deepen the foundation of outperformance in the U.S. and in the UK at this stage, and then we can have a debate as to whether we move the bar, the goal post up or not. But so far, so good. All these business units are firing on all cylinders, and we are really keen to grow in the markets where we have. The good news is that the sandbox in which Intact operates is 10x bigger than what it was 8 years ago. There is outperformance everywhere. So, we can just keep our head down, grow where we operate today and meet our earnings growth objective, well outperforming from an ROE point of view. And a few years from now, we can debate whether 500 basis points is the right objective. But we think there are very few companies and very few industries that have generated this sort of outperformance, and we are very keen to protect that outperformance. And if we can grow it, we definitely will. Lemar Persaud Appreciate the time. Operator Your next question comes from John Aiken from Jefferies. Please go ahead. John Aiken Good morning. Thanks for squeezing me in. Charles, I wanted to revisit some of the - a comment you made in your prepared commentary about the specialty lines and basically a little bit more room for improvement. Now, I think this is in context of when you are talking about digital and AI, are you willing to give us a couple of examples just for my own edification in terms of what you are trying to do with specialty lines? And then I guess pushing my luck, can you go - actually discuss whether or not you are willing to quantify what the impact of these improvements could be? Charles Brindamour So, if you look at the specialty lines business, now it's running in the 80s, in a favorable environment. And I think the sophistication lift we can get and keep us operating in that zone on a sustainable basis. That's really what we are trying to achieve. The example I would give you, just to be very concrete is that in Canadian commercial lines, so our main street commercial lines operation. You have a very sophisticated pricing engine, machine learning based in many segments. The holistic view of expected profit per customer that is used to manage the business, all of that is automated, and it generates tens of billions of price points in a product in a given province. We are not there in other jurisdictions, and that's where I see a fair bit of upside like we are racing to deploy segmentation models. We are not working yet with systems who are as modern as we have in the Canadian ecosystem, so we are investing heavily in our systems in the U.S. as well as in the UK and increasingly in Europe. That helps lift the quality of the data you use when you segment. And so the performance is really good. But when I look at the depth of the sophistication that's in the field right now outside of Canada, I see a lot of upside myself. And that's why we are investing massively in that space. John Aiken Fantastic. Thanks Charles. I will leave it there. Operator And we have time for one more question from Nigel D'Souza from Veritas. Please go ahead. Nigel D'Souza Good morning. Thank you for taking my question. I just had some minor follow-ups for you on cat losses. Just to get a better understanding of how it plays out going forward, should we expect that most of the losses from recent events that's going to be reflected in Q3? And is any of it going to bleed into Q4. Could you remind us how long the tails are for these type of events. So, in future quarters or future years, how long could your PYD be impacted? And the last point on the Jasper wildfires, there is a lot of disruption to businesses and potential lost revenue. So, any commentary or color on the potential impact on your commercial lines from those wildfires? Charles Brindamour So, just in aggregate cat losses, you should not expect any of the Q2 and Q3 losses to bleed in Q4. In fact, the pattern we have shown over time is you have favorable development in subsequent quarters because we go to the ultimate very fast, in fact, faster than the industry. And you see that in big cat moments, our outperformance can shrink for a quarter or two quarters as the industry moves to ultimate. So, I would not expect adverse development from current cats outside of the current quarter. That's the first point. And then there was... Darren Godfrey Commercial. Charles Brindamour Yes, commercial and Jasper. Patrick Barbeau In the overall kind of guidance or color that Charles provided earlier around these events and the potential impact with the catastrophe retention. When we project the ultimates, we fully take into account all coverage. So, the cost to repair, we build the houses, the content, the additional expense during the evacuation, including the business interruption, all of the clients that are interrupted during the evacuation, but also for the clients who need to be rebuild and that's where the business interruption period might be longer. So, to your point, by the end of Q3, will book fully the full extent of that, that's including that business interruption potential. Kevin Lemay Perfect. Thank you everyone for joining us today. A replay of the call will be available for one week, and the webcast will be archived on our website for 1 year. A transcript will also be available on our website in the Financial Reports section. Our 2024 third quarter results are scheduled to be released after market close on Tuesday, November 5th, with the earnings call starting at 11:00 a.m. Eastern Time, the following day. Thank you again and this concludes our call for today. Operator Thank you, sir. Ladies and gentlemen, this does ended - conclude your conference call for today. Once again, thank you for attending. At this time, I will ask you that to please disconnect your lines. Thank you.

Humana, Inc. (HUM) Q2 2024 Earnings Call Transcript

Lisa Stoner - Vice President, Investor Relations James Rechtin - President and Chief Executive Officer Susan Diamond - Chief Financial Officer Good day, and thank you for standing by. Welcome to the Humana Second Quarter 2024 Earnings Call. At this time, all participants are in a listen-only mode. After the speakers' presentation, there will be a question-and-answer session. [Operator Instructions]. Please be advised that today's conference is being recorded. I would now like to hand the conference over to Lisa Stoner, Vice President of Investor Relations. Please go ahead. Lisa Stoner Thank you, and good morning. I hope everyone had a chance to review our press release and prepared remarks, as well as a letter from the CEO, all of which are available on our website. We will begin this morning with brief remarks from Jim Rechtin, Humana's President and Chief Executive Officer; followed by a Q&A session with Jim and Susan Diamond, Humana's Chief Financial Officer. Before we begin our discussion, I need to advise call participants of our cautionary statement. Certain of the matters discussed in this conference call are forward-looking and involve a number of risks and uncertainties. Actual results could differ materially. Investors are advised to read the detailed risk factors discussed in our latest Form 10-K, our other filings with the Securities and Exchange Commission and our second quarter 2024 earnings press release as they relate to forward-looking statements, along with other risks discussed in our SEC filings. We undertake no obligation to publicly address or update any forward-looking statements and future filings or communications regarding our business or results. Today's press release, our historical financial news releases and our filings with the SEC are also available on our Investor Relations site. Call participants should note that today's discussion includes financial measures that are not in accordance with Generally Accepted Accounting Principles or GAAP. Management's explanation for the use of these non-GAAP measures and reconciliations of GAAP to non-GAAP financial measures are included in today's press release. Any references to earnings per share, or EPS, made during this conference call refer to diluted earnings per common share. Finally, this call is being recorded for replay purposes. That replay will be available on the Investor Relations page of Humana's website, humana.com, later today. Thanks, Lisa, and good morning, everyone. Thank you for joining us. Let me start by just saying that it's a privilege to be able to serve as Humana's President and Chief Executive Officer, and I want to say thanks to the Humana Board of Directors for providing me this opportunity. I also just want to say thanks to Bruce for the last six months of his mentorship and partnership. It's been really, really great, and I actually look forward to continue to work with them over the next year. So Bruce and our 65,000 teammates have built a great company here and it's pretty exciting to be a part of it. I shared some thoughts on Humana and the industry and the opportunity ahead in the letter that I posted on our Investor Relations website this morning. I encourage everyone to take a moment to read the letter that goes along with our second quarter prepared remarks in the earnings release. I'm not going to repeat what is in the letter, but I do want to hit a couple of themes. So let me start by just reinforcing what I think is basic truth about the business. It's a good business, it's good for our members and it's good for our patients. This is well documented in my opinion. CMS and the Federal government, state government, and by extension even taxpayers are also our customers. I think we need to constantly remind ourselves of that. What we do creates value for those customers as well. We need a regulatory environment that allows that value to be fully realized and that requires constant collaboration and adjustment. We need to be a proactive partner with CMS in that process, and we need to do this to make sure that we've got a long-term, stable Medicare, Medicaid program. This is also good for investors, for all of you. And I think you guys know that the sector fundamentals have not meaningfully changed. They're still attractive, and we still have differentiated capabilities to compete in that space. We understand that there is frustration with the volatility that we've been experiencing. I want you to know that we also acknowledge that right now we are not achieving our full potential. The external environment has certainly been difficult. However, the message that I want to keep driving home is that we need to see the external environment for what it is. It's context. We need to shape it to the degree that we can and we otherwise need to be focused on the things that we control within that context. That's our product, it's our pricing, it's our clinical capabilities, it's admin costs and it's growing our business. To execute well against the things that we do control, we need to be incredibly focused on operating discipline. We're good at operating discipline, but we need to be reminding ourselves of that day in and day out as the external environment changes. We also can do a better job with multiyear planning in order to deliver consistency and performance over time. We got great teams. We know how to do this. It's simply about maintaining focus on the things that we control, even when the environment around us is shifting. Now let me turn to second quarter performance. I'm going to give a quick headline. I'm going to give some examples to support that headline, and then I'm going to come back with some implications on our outlook. The headline today is that our second quarter results exceeded expectations. We feel good about where we are at mid-year, but we did experience some medical cost pressure in the quarter. So let me expand on that a little bit. Much of the good news comes from our Medicare business, which is outperforming the expectations that we had at the beginning of the year. Our member growth is better than we expected. We raised our forecast by 75,000 members. That means that we should grow at just over 4% for the year. Our benefit ratio for the quarter was lower than we anticipated. That was driven by claims development and higher than expected revenue, and that was also offset by the higher inpatient costs that I referenced earlier. More specifically, inpatient admissions were higher than we expected in the back half of the second quarter. That pressure has continued into July. For now, we believe that planning for continued pressure within our guidance is the right approach, that we also feel good that this pressure ultimately can be mitigated. We've taken several measures to mitigate that pressure. So, for example, we're continuing to ensure clinical appropriateness of admissions, especially in light of the 2-midnight rule we are enhancing claims audits and we are negotiating with provider partners to achieve better clinical and contractual alignment. In Medicaid, we're excited about our continued growth through both contract wins and member growth, and we continue to wait for additional RFPs. We have some modest claims pressure in Medicaid, but we do not expect it to impact our full year results. In CenterWell, Primary Care is delivering strong clinic and patient growth, and we're confident that we're on track to mitigate v28 as it phases in. Overall, our pharmacy volumes are in line with plan and we continue to drive lower cost to fill, particularly in our less mature specialty pharmacy business. The home business has generated high single digit admission growth and the team continues to improve their cost structure, anticipating continued rate pressure in that space. We continue to make progress managing our admin costs and where had a plan for the year. Broadly, we are focused on automation. This is in reducing our cost to fill in our pharmacy business and it's also in lowering member service costs within our Insurance segment. Give just a few examples of the type of work, actually really good work, that our teams are doing. We're seeing an increased Medicare claims auto adjudication rate by about 70 basis points. This does improve the provider experience and it does also reduce claim processing costs. We've optimized logistics across our specialty pharmacy facility in a way that reduces transit times and also lowers average delivery costs. We've improved our digital enrollment experience. This is leading to higher conversion rates and again, it's lowering our distribution costs. Finally, we're making good progress on multiyear initiatives. We recently announced a partnership with Google. This will help accelerate our AI efforts. That will in turn help reduce cost and improve the consumer experience. We're excited about a recent investment that we made at Healthpilot. Healthpilot uses AI to make the consumer purchasing experience better when shopping for Medicare Advantage. And we just entered into a lease agreement with Walmart that should help accelerate our primary care clinic. The implication as we look forward is that we're reaffirming our full year 2024 adjusted EPS and benefit ratio guidance. This prudently assumes that the higher inpatient costs will continue. Even as we work to mitigate that pressure. We're looking ahead to 2025. We continued expansion in adjusted EPS growth as a first step on what will be a multiyear path to a normalized margin. We continue to feel good about our bid assumptions and our product portfolio as we head into AP. I am excited about all of the momentum and the opportunity ahead. And so with that, I'll just remind you that we posted the prepared remarks to our Investor Relations website so that we could spend most of our time on Q&A today. And we will now open up the lines for your questions. Our first question comes from the line of Ann Hynes with Mizuho. Hi. Sorry about that. She cut out. So maybe going to the inpatient trends, is it really only the 2-midnight rule you're seeing pressure, or are there other areas of pressure that you're seeing? Thanks. Susan Diamond Yeah. Hi, Ann. Happy to take that. So, yes, and as we described in our previous commentary, both in the first quarter and then at conferences in the second quarter, we have seen some variation in our month-to-month inpatient results for, and then also the avoidance rates as we implemented the 2-midnight rule requirements, which, if you remember, that was a meaningful change and we need to make some assumptions around how it impact our historical patterns. As we described in the first quarter, our avoidance rates initially were lower, but then ultimately did come in line with our expectations by the end of the first quarter. Those have remained stable and continue to be in line with what we would have expected. The inpatient absolute level, however, has seen some more variation and was higher in the back half of the second quarter, in particular. As Jim mentioned, that has continued into July at relatively similar levels. Based on everything that we are seeing, including the fact that these continue to be lower acuity and lower average cost, as well as the fact that we continue to see corresponding reductions in non-inpatient on observation side, it does all point to a belief that it is likely largely due to further impacts from the 2-midnight rule implementation. We would say this is also consistent with what we've seen reported from the hospital systems with their results in terms of volume and revenue per patient. So we do believe it's all consistent. With respect to July, it is relatively consistent. We are seeing just a slight amount of COVID as well on top of that, but otherwise consistent. So as far as everything we have visibility to right now, it does seem to have stabilized, but is higher than we had anticipated entering the second quarter. Our next question comes from the line of Sarah James with Cantor Fitzgerald. Sarah James Thank you. The guidance implies a good step up in second half MLR. Can you speak to how much of that is seasonality versus assumed continuation of the July trend? And is there a way to break out the impact of the increase inpatient in July on the 2Q MLR? Susan Diamond Hey, Sarah. Yes, so in terms of the second half MLR, as we said, it does anticipate that the higher inpatient volumes, which are partially offset by lower average unit costs and then those lower observation stays will continue into the third quarter and the back half of the year. So that is fully accounted for. To your point, there is some workday seasonality that impacts the quarterly progression as well. For the third quarter, specifically, it is contributing about 80 basis points to the expectation for the third quarter MLR. So that is accounted for as well. The offset to that is largely in the fourth quarter, where we expect to see favorable workday seasonality relative to last year. I think your second question asked whether the higher July activity impacted second quarter results, which obviously it wouldn't. That would be considered in our third quarter results. Sarah James Right. Sorry. Is there a way to quantify the July impact on MLR? Thank you. Susan Diamond No. So I would say again, the core admission volumes is in line with what we had anticipated. Based on the second quarter performance, there is a slightly higher amount due to COVID, which again, I wouldn't say that's overly concerning to us, and given it's clearly COVID related, we would expect it not to persist for the full balance of the year. But something will certainly continue to last. Our next question comes from the line of Andrew Mok with Barclays. Andrew Mok Hi. Good morning. Hoping you give a little bit more color on the MLR progression this year. You're guiding 3Q insurance MLR up about 100 basis points sequentially, but it sounds like you're leaving that assumption relatively flat. Is that right? Because I would think 4Q MLR would be even higher than 3Q MLR just based on normal seasonality. Just want to understand those two points. Thanks. Susan Diamond Yeah. When you think about the back half of the year, we do anticipate higher MLRs for the third quarter relative to last year. Relatively consistent, which again includes that workday impact I just mentioned. For fourth quarter, we obviously saw that very high utilization in the fourth quarter last year. Obviously, we jumped off of that in terms of expectations for this year, we see some slightly higher incremental pressure just because of the expectation of abnormal trend on top of last year's jumping off point. But because of that favorable workday seasonality that I just mentioned, it will positively impact the fourth quarter MLR, which is going to offset some of that. Our next question will come from the line of Justin Lake with Wolfe Research. Justin Lake Thanks. Good morning. First, the higher inpatient cost, if I just run some simple math, your typical seasonality first half, the second half on MLR, typically pretty flat to up slightly. Let's call it zero to 50 basis points. So it looks like you're up closer to 125. So am I right in thinking that this impatience pressure is about 100 basis points to MLR in general? If not, can you quantify it somehow for us in terms of the level of pressure that this is specifically putting on MLR? And then, what's embedded in the second half relative to what you expected previously. And then you talked in the prepared remarks about being comfortable with your 2025 bids. You said this came in the back half of the quarter, so that's second half of May. Those bids are due in the beginning of June. How do you get investors comfortable with the fact that your bids would be able to absorb this type of pressure given that you didn't see it until right when bids were being submitted? Susan Diamond Yeah. Hi, Justin. So in terms of the MLR seasonality, there are some impacts year-over-year just because we continue to see increasing pressure last year. So it sort of impacted the progression we saw last year. With respect to this year, when you think about first half and second half, there is some favorability in the first half of the year that offsets some of the higher costs that we did see beneficially impacting the benefit ratio. And those are some of which are one time in nature where they won't run rate. Some are unique to the first quarter or the first half of the year. Typically, things you can think of like prior year claims development, which we've acknowledged has been favorable versus our expectations. We've also mentioned that we saw favorability in our '23 final MRA payment, which is more one time in nature still positive, but won't run right into the back half of the year. So some of those things are disproportionately impacting our first half MLR this year relative to some prior years and so, obviously won't repeat in the back half, which can create some differences in what we're expecting first half and second half. So within our second half assumptions, as we've said, we have assumed that the higher absolute level of inpatient volumes plus the naturally offsetting unit cost and observation stays that we've experienced, those are all assumed to continue for the balance of the back half of the year. And then, as we said, there are some workday seasonality impacts that are a little bit different this year. They're also embedded in that as well. As far as '25 bids, to your point, we submitted these bids prior to some of the development of this inpatient pressure. So that is not explicitly contemplating the bids, but we would say some of the offsetting positive news, the higher risk scores in the final MRA payment, as well as the lower inpatient unit cost, the lower observation stays, and some of our other favorable prior year development coming from things like claim cost management and audits were also not contemplated in the bids. And so more durable. And so all told, and considering all of those factors, we continue to feel good about the bid assumptions in the aggregate and the ability to deliver the margin and earnings expansion that we had always contemplated. Our next question comes from the line of David Windley with Jefferies. David Windley Hi. Thanks for taking my question. I wanted to ask a clarification and then a broader question. The clarification being, Susan, I think you had previously said that 2-midnight rule was worth about 50 to 75 basis points in the MLR. I wondered if you could give us an updated number on that. And then the broader question I have is, over multiple years of value creation plan activity, the company's endeavored to drive efficiency and take cost out. I'm wondering if essentially you've cut the muscle, if you've cut so much cost that your kind of anticipatory mechanisms and ability to react and act quickly on elevated cost activity has been hampered by the depth to which you've cut costs. Thanks. Susan Diamond Yeah, David. So I'll take the first question on the 2-midnight rule and then hand it off to Jim for your second question. So yes, I think the impact that you referenced was what we anticipated going into the year relative to the 2-midnight rule. Obviously what we've seen, if the higher inpatient costs are in fact attributable to the 2-midnight rule, which again the information we have would seem to suggest that it generally is, then that would obviously have a higher impact than we had expected. All told, when you consider the positive prior year development as it respects claims and the unit cost and the observation stays, when you take all of that in total, we are able to mitigate a significant portion of that, but not all of it. And so intra year, the remaining offset is coming from that favorable MRA, which again we expect to continue, which is why we continue to feel good about the $16 for this year and $25 for next year. But we haven't sized the incremental impact for the 2-midnight rule, and I don't have that information sitting here today that I'd be prepared to do that on this call. James Rechtin Yeah. Hey, I can jump in on the cost management question. First of all, it's good question. It's one of the questions that I was asking and staring at when I first came in here seven months ago. The short answer is, I don't see any evidence that we've done anything that has cut in the muscle today. And I think that's the most important thing. Anytime you go through a cost transformation like this, you've got some low hanging fruit upfront and then you have a lot of harder work that is tied to the things that we talked about earlier, automation, using technology to do process redesign, et cetera. The quick hits you get quickly and the rest of it takes real planning and investment over multiple years. The company has done a nice job of planting the seeds for that multiyear cost management and there's more to do. When you think about the nature of this business and what technology can do to take cost out over time, there is still more opportunity. That opportunity is just going to be phased in over multiple years. It's not going to be the big jump that we saw a year, year and a half ago. Hi, everybody. Maybe just stepping back. I know, Jim, in your letter you talk about multiyear opportunity for margin recovery and some of the discussions we've had with the company earlier in the year. The thinking was, given the market competitive environment, given some of the restrictions on tweaking benefits, that we should think of it in terms of 100 to 150 basis points of margin recovery, MLR and then margin maybe each year for the next few years. I wonder if you have any updated thoughts on how fast we can see that margin recovery. I know you reiterated long-term, you think it could be 3% target. I think that's before investment income. Can you give us any updated thoughts on how the progression looks over the next two or three years? James Rechtin Yeah. Let me hit a couple of things in there. So, first of all, I want to separate two concepts. We have talked about the multiyear margin recovery that is really driven by the regulatory environment, what you can do in any one year with TBC, et cetera. And we really don't have any change to the commentary that we have made on that previously. The second thing that I referenced is multiyear planning. And when you think about multiyear planning, I'm going to go back, actually in a way to the comment that I just made. If there's a place that we're going to have to be more disciplined over the coming years, it's really in how we're measuring and evaluating the return on the expenses, whether it's capital or whether it's operating expense that we have in any given year. So that we're optimizing those decisions and then making sure that we've got the processes, that we're not just operating with discipline in one year period of time, but we're driving the accountability over years two, three, four and five that go back to that investment you made in year one. That's the place where I think that there's more opportunity and the benefit of that is just getting to more consistent performance year-over-year-over-year-over-year. That is kind of really grounded in how do you optimize shareholder value over multiple years. So that's a different concept or a different thing that I am commenting on in the letter from the margin recovery that we need to make sure that we're building into our benefits and our pricing. Our next question comes from the line of Kevin Fischbeck with Bank of America. Kevin Fischbeck Great. Thanks. Maybe two quick questions, maybe just to wrap up that last point, Jim. Would you say that this is a change for Humana that you're bringing to this, that maybe this was a shortfall, multiyear planning with a shortfall relative to historical? Or are you just saying this is something you always have to do and you're just going to continue to do it? And then, I guess, second, on the provider business, can you comment a little bit more about the MLR trend there? Are you seeing the same inpatient pressures there, or is there anything else that you would spike out on that side of the business? Thanks. James Rechtin Yeah, I hit the first one, and then I'll hand this over to Susan to comment on the second. It's not so much that it's a change as it is something that we can get more disciplined about and we can get better at. Nature of this business, Medicare Advantage in particular, is that it's an annual cycle business. You guys know that we talk about it all the time, annual repricing, annual rate notice, annual AEP and member growth. And in that environment, it can be challenging to really be disciplined about how you think about three, four, five-year investments. And again, that's not just capital investments, that's operating investments that you're making in any given year. And so it is something that the company thinks about. It's also something that the company can get better at. Susan Diamond Yeah. And Kevin, on your second question, with our provider business, I would say the highest level similar results to the health plan, although on the claims side, I would say not quite as much inpatient pressure as we've seen. And we -- that's consistent, I think, with what we talked about earlier in the year where we weren't seeing as much pressure in the risk book from some of that inpatient activity when it started to emerge. They've also, as I've said before, consistently demonstrated a better impact to work with the hospital systems on those authorization requests and determining the appropriate level of care, which oftentimes results in not needing an inpatient stay. And again, just better than what we see on average within the health plan. They've also seen some favorable MRA in their '23 final payment. But then we also acknowledge that CenterWell, because they do have an agnostic platform, they don't get the same level of real time information as we do. And so we are taking a little bit of a cautious approach as we think about their performance. It's harder to estimate the impact of change that's still running through the system. So I would say generally not inconsistent with the health plan, but not quite at the same level. Our next question comes from the line of Joshua Raskin with Nephron Research. Josh Raskin Hi. Maybe just shifting gears, can you speak about your expectations for the PDP segment in 2025, including expectations for membership and then profit and margin. And then maybe based on that benchmark data that we saw this week, what should we take away from the industry bids? And maybe lastly, any commentary on expectations of participation in that demonstration project? Susan Diamond So, hey, Josh. So yeah, there's a lot going on, obviously in the Part D side, particularly PDP. As we said, it is hard to really understand how everyone might have approached their bids for 2025, particularly in the standalone Part D space. As we said before, selection in terms of your underlying membership is really important, and we each have a little bit of a different product strategy, which may have caused us to approach the bids differently. I would say broadly, I think the industry was focused on mitigating some of the increased exposure and liability risk that we all have in the way that the program will be constructed for '25. With the information that was released this week on the benchmarks, as we've all seen, it does suggest that the direct subsidy maybe is going to be higher than what certainly analysts had expected. It's impossible to know what each company might have anticipated, but what is nice to say that it is more reflective of some of those higher costs that we've been saying the industry is going to have to deal with in 2025. As far as the demo, honestly, there's still a lot of questions about how the demo will work that we're all awaiting additional guidance from CMS on that, and so too early to say whether we're going to be able to participate or nothing. And as far as the direct impact of the direct subsidies and the benchmarks, again is always the case, we aren't going to comment on that specifically, recognizing new bids are still open and people will be making changes in light of that. So certainly, we'll talk more as we get past the bid submission timeline, but right now, for competitive reasons, we just -- we won't be commenting specifically. Our next question comes from the line of Ben Hendrix with RBC Capital Markets. Ben Hendrix Thank you very much. Switching over to Medicaid, it seems like a lot of your peers saw some utilization and acuity headwinds in those books, but you noticed some favorability in Florida and seems like you might have been a little bit better forecasted there. Could you talk about kind of what you're seeing specifically in that key market? And then maybe what you're noticing in some of your newer Medicaid markets in terms of utilization? Thank you. Susan Diamond Yeah. Ben, so as you pointed out, we do think our results are probably a little bit different than some others have reported. And that is because I think we've always said we tried to take a conservative approach to how we thought about the impact of redetermination. Assuming that ultimately we would only retain 20% of the members who gained access through the PHE, and made the assumption that the acuity of those members that were retained would look like more like the historical Medicaid performance versus the lower acuity we saw through the PHE. I would say that has all largely proven to be true. So -- and we called out Florida specifically because it's the best representation of that. We're obviously the largest membership and would be impacted most significantly from redeterminations. And Florida is performing slightly better than our expectations. So that is positive. We did call out in our remarks we are seeing in our newer states, discrete pressure. It's a little bit different in each one. Oklahoma, as an example, is pharmacy related. We understand everybody's seeing that there are risk corridors in place that mitigate the exposure on that, which is good. In Kentucky, it's behavioral related, which, again, I think others have called out as well. The team's working hard and has mitigation opportunities across each of those states that they're working on. And then ultimately, we do feel good about our discussions with our state partners, and that ultimately that they will adjust the rates to be reflective of those trends. So all things being considered, we still feel good about the Medicaid performance in '24 relative to our expectations, and then also on a go forward basis, given all the items I just mentioned. Our next question comes from the line of Stephen Baxter with Wells Fargo. Stephen Baxter Hi. Thanks. Just a quick clarification first and then an actual question. Susan, I think in an earlier response, you said you feel good about the $16 of EPS this year, and then feel good about 2025. I think some misheard the comment on 2025 is a specific value you are offering as an EPS expectation. Can you just confirm first if you were offering any kind of comment on 2025? And then my actual question is, as we think about the MLRs and the incremental margins on the few hundred thousand members in plan and county exits, any sense you can give us on that? Just trying to wonder if that's actually an EPS driver for you year-on-year, or is this something that incrementally could be -- something you just have to manage through in context of everything else you're trying to achieve with bids and profitability next year. Thanks. Susan Diamond Yeah. So, yes, definitely want to clarify here's what's interesting. So yes, we feel good about the $16, and yes, we feel good about our 2025 assumptions. I did not mean to suggest that we're sharing an EPS target for 2025. Obviously, we've been clear. We haven't given any forward guidance for '25 and would expect to do that on our normal timeline. So I was just making the point that based on everything we know, we continue to feel good about the 2024 results and what we're planning for '25. As far as exit specifically, so as we've been saying, given the TBC limitations and the trend in IRA and v28 that we're having to price for in '25, that a lot of that would fully sort of be offset by the benefit changes you could make and not leave much incremental room for margin recovery in the aggregate. The plan exits, though, do provide an opportunity to actually get margin expansion in terms of percent and absolute earnings because we do have planes that are running at a loss. And so, as we said before, we studied the performance of our plans in each market very closely, and if they were performing at a loss and did not have a reasonable path to getting to at least breakeven performance in a reasonable period of time, we did consider an exit as a better solution there. So there are cases where we'll do that and that will be incrementally positive to our earnings progression. But ultimately, as we said, the absolute level of earnings growth is very dependent on our ultimate membership change for next year. And in this environment, we've acknowledged there's a wider range, potential outcomes. And so we'll need to see the landscape before we can comment further on member growth and then certainly EPS expectations for next year. Our next question comes from the line of Scott Fidel with Stephens. Scott Fidel Hi, thanks. Good morning. Was hoping you could maybe just sort of catalog or walk us through the different inputs into the $3 billion raise to the revenue guidance. Obviously, saw the updates to the MA and PDP membership changes, but in isolation, those wouldn't sort of amount to for anything really close to $3 billion. So know there's probably some other drivers there, whether it's Medicaid or CenterWell. Just to be helpful, Susan, if you just walked us through those different pieces. Thanks. Susan Diamond Yeah. Hey, Scott. So, yes, the change to the revenue guidance is the largest driver, is by far the membership. When you consider the magnitude of the increase in expected membership for the year, that'll drive both revenue and claims. Right? And we've said before, new members on average, you can think of as having little contribution, particularly, added membership in the back half of the year where the commission costs run higher for that first year. So the main driver is membership. But as we said, we did see some favorable outperformance on our '23 final year MRA and some intra year positivity on our revenue risk or estimates as well. That's included, but I would say the majority by far is membership related. Our next question comes the line of Lance Wilkes with Bernstein. Lance Wilkes Yes. Jim, could you describe a little bit of how you're morphing the management process of a company and any sort of Oregon talent changes you're making there and any sort of timing related to a strategic review? And then maybe as part of that, what are your top priorities for taking operating expenses out, both in light of the member reductions and then just obviously as part of trying to recover your margin? Thanks. James Rechtin Okay. So there's a lot in there. Let me see if I can capture this. Management process, strategic review, cost management. Did I miss anything? Margin recovery, yeah. So I'll try to hit each of those succinctly here. Management process. I think the biggest thing that we're doing around management process is actually what I referred to earlier, is trying to take up to the next level our discipline of looking out multiple years, how we're measuring performance over multiple years against the investments and the expenses and the things we're doing in any given year, and then how do we make sure that we're driving accountability over those multiple years? I mean, that is the single biggest change that obviously then dovetails into strategic review. We're in the midst of that. We're going a little deeper than I think we would in normal year, largely because I'm new to the team. And we're really trying to use that process to implement those management processes that I just described. So we're in the middle of that process. We will have more to say about the exact timing and the exact outcomes of that sometime early to mid-next year. The cost management, there are two different things in there. One is how do we manage variable cost? And so the team actually has good processes around that. Of course, we're tightening them up given the range of membership outcomes that we could have this year. But that is a pretty standard process that you're simply honing, taking variable cost out with membership. And then we are diving deeper and deeper into how do you actually drive real process redesign with automation technology. I point back to the partnership we've got with Google around AI. What we're thinking about, even in things like distribution costs by being able to drive more efficient digital distribution. All of those things are about driving long-term cost management, which hits both fixed and improves variable over time. Margin recovery. I'm going to go back to the same place that we've been on margin recovery. It's going to take -- we expect to be at least 3% in our Medicare Advantage business. It's going to take multiple years to get there. That is largely driven by the regulatory environment, TBC, et cetera. And that is based on some basic assumptions, kind of reasonable assumptions, about how rate and trend is going to develop over that period of time. We think we'll be back to normal in 2027, back to a normalized margin. And that's what we've communicated in the past, been pretty deep into those numbers, and I feel good about the direction that the team has given. Our next question comes from the line of Michael Ha with Baird. Michael Ha Thank you. Just a quick clarification on Op Ex, first, and my real question. I know your press release mentioned some of your lower than planned admin expenses were considered timing in nature, but wasn't that also mentioned in 1Q? So are those timing items expected to flip back into third quarter and fourth quarter? And then my real question coming back to Justin's question on bids, apologies, I may have missed part of the answer. But sounds like this elevated inpatient utilization was not embedded in '25 bids. So if it were to persist through to '25, and presumably if it is an industry wide dynamic, then I imagine your relative competitive positioning would in theory be unchanged. But I imagine this would also then impact your own expected MA margin recovery for next year. So all-in-all, if it were to persist, wondering if you could discuss how this could incrementally impact your MA margin progression next year versus your prior expectations. Thank you. Susan Diamond Yeah. Michael, so on the OpEx, yes, we did mention both in the first quarter and then second, that some of the favorability we've seen in administrative cost is timing in nature. And that's just a difference in when we projected, we would have certain spend and when it's now expected to be incurred. Some of the areas where it's natural that you might say is marketing and just the timing and the opportunity they see in the AEP versus OEP versus ROY and then going into next year. IT is also one that can be difficult to predict the exact progression of when projects will be completed. So there are a number of things where while it's favorable in the quarter, we would expect that it's still going to be spent for the full year, and so then we'll flip out in the third or fourth quarter. On the bids, what we want to try to convey is, we did not anticipate this higher utilization in our bids given when it developed relative to the deadlines for filing those bids. So that will be incremental pressure relative to our discrete medical cost assumptions and bids. However, we also did not incorporate the lower unit costs, the lower observation stays, nor the higher risk scores that we've seen develop in the first half of the year either. And because those have largely offset, those are also expected to be durable into '25. All considered, we still feel good about the MLR expectations that we have within the collective assumptions in our 2025 bids. So we are at this point, much like we're assuming it'll continue in the back half of the year. We've looked at our '25 assumptions and if that continues through the big duration of '25 with those other offsets, again, we should be back to a similar position as it respects the MLR that we had planned for within our '25 bids. Our next question comes from a line of Jessica Tassan with Piper Sandler. Jessica Tassan Hi, thanks very much for taking my question. So I wanted to follow up on that. How are the higher than anticipated risk scores that you referred to in the prepared remarks impacting your view of the v28 headwinds in '24 and '25? And is the favorability related to any kind of specific efforts like IHEs and any reason why it wouldn't compound or effectively double year-over-year in 2025? Thanks. Susan Diamond Yeah. Jessica, so the favorability we saw on the 23 file is primarily related to new members in 2023 and that's where, based on their data enrollment, we just don't have the full claims history in order to know specifically what their subsequent year risk score will be, because we just don't have the benefit of the claims. So that typically, if we do see favorability is the source of it. And so that's what we've seen. It's largely within -- the membership growth was largely concentrated in those LPPO [ph] claims, so that's where we've largely seen it. It would have -- I would say the v28 impact is sort of unchanged in terms of our thinking. It's not now on higher membership, but I would say the outperformance on the '23 final MRA doesn't have a literal impact in terms of our v28 thinking, but proportionately because we have more members, it'll just be accounted for within that. In terms of the outperformance we did see, like I said, because it was related to the new members where we didn't have the full visibility and that was not contemplated in our '25 bids. With the visibility we now have, we would expect to see that recur into 2025 and be another mitigate to offset higher inpatient utilization if it also happens to maintain throughout '25. Our next question comes from the line of John Ransom with Raymond James. John Ransom Hey, good morning. Two kind of super high level questions. It looks to me like the industry is losing the argument in Washington. You've seen a couple of things that suggest taxpayers are spending 13% or so percent more on Medicare Advantage than they would be on straight Medicare fee for service. So I wonder if you think your advocacy efforts are sufficient. And what is the kind of elevator pitch to a senator when he or she asks, is MA a good deal for the taxpayers? Apples-to-apples, because it seems like there's a split question. The second high level question is, if you just look at your G&A long-term opportunity, incorporating all the tools of AI and everything you know today, what is the kind of floor on how far -- how low you think you could drive G&A over, say, the next five years? Thank you. James Rechtin Yeah. So DC policy advocacy, how do we make the elevator pitch and then comment on G&A? Let me just hit the G&A one real quick. That one's a little bit easier. We are working through that question, among others right now, through the strategic review that we're doing, et cetera. We'll have more to say about that next year, early to mid-next year. And so I'm going to defer on that question for the moment. On the DC policy, so we've had a lot of conversation about that internally. And what I would keep going back to is, number one, we know that we deliver value to our members and our patients. That is very well documented. We get better outcomes. We deliver better health security by lowering the cost to members for the care that they receive and giving them access to more benefits. We also know, and it's pretty well documented, that we deliver like for like benefits at a lower cost than what original Medicare does. Those two things mean that there's a value proposition for members and for taxpayers. What we can do a better job of, and part of what I think the entire industry needs to be focused on is building the case for the second of those two things even more tightly and then better explaining and understanding what of that value does accrue back today to taxpayers. What doesn't and how do we actually collaborate with CMS to make sure that the regulatory environment allows that value to accrue back or some of that value to accrue back? None of that should be harmful to the MA sector. In fact, I would argue that it helps the MA sector, are getting tighter and better and understanding the impact on taxpayers, how the regulatory environment shapes that, what we can do to create a long-term value proposition for taxpayers that creates real stability for the Medicare and Medicaid program over time. That's good for everybody. It's good for the MA sector, it's good for the member, it's good for taxpayers, and that's what we've got to focus on getting back to. Our next question comes from the line of George Hill with Deutsche Bank. George Hill Yeah. Good morning, guys. Thanks for taking the question. I guess the question, as it relates to the 2025 bid strategy, I guess, first of all, is there a way to characterize the approach to, like, how much -- for how many beneficiaries did you guys kind of want to remove the plan or exit a plan as a way to preserve margin or pursue margin, and to what degree? I guess on the other side, are you guys just looking to restructure plan benefits? And I think even at a higher level, the question I want to ask is, like, are you guys willing to quantify, like, how many individual MA members you provide plans for now that will not have that plan offered in 2025? James Rechtin Yeah. Let me jump in on this one. So the question -- well, some of this is going to be a repeat of things that we've said in the past. So we've got a set of plans that are not profitable, that we don't see a path to making them profitable. We have exited those. That impacts a number of our members. In most cases, and the vast majority of cases, those members will have access to another Humana plan. So there's very few actual geographies will fully exit. We have another set of plans that is either marginally profitable or marginally unprofitable, but we see a path to recovering the profitability of those plans, and we are working on that through reducing benefits and changing our pricing. And then we have a set of plans that are actually quite attractive, how they perform today, and we are protecting those plans. That is how we have approached this. Today, for competitive reasons, we're not prepared to give specific numbers of members that fall into each of those categories. Susan Diamond Yeah. And I think, George, just to add to what Jim said, we've given you the overall expectation that we'll reduce membership a few hundred thousand members, primarily related to plan exit. So you can assume, right, it's not a small number, within that there is an assumption that obviously we will retain some of those members because as Jim said, in almost -- virtually all of the counties where we're having plan changes, there is another plan option available to our beneficiaries. So there's an inherent assumption. As Jim said, we don't want to give details right now because again, there are still changes being made to bid submissions through the normal process. As we get later into the quarter, there may be an opportunity at another public forum once bids are filed where we can provide some more detail. Our next question comes from the line of Erin Wright with Morgan Stanley. Erin Wright Great. Thanks for taking my question. In light of the disciplined approach that you're talking about in the ongoing strategic review, how are you thinking now about capital deployment from here, whether it's prioritizing the alignment with the Medicaid book and ability to service duals, or is it more on the care delivery assets, and what is your level of focus or thinking even on the organic opportunities, I guess, generally speaking at this point. Thanks. James Rechtin Yeah. So let me start by characterizing where we believe growth opportunity is over and above what's in the Medicare book. And again, this is largely consistent with what the company has done in the past. We believe that there's growth opportunity at CenterWell. We believe there's growth opportunity in Medicaid. And to your point, there is significant kind of synergy or interrelated benefits between the Medicaid growth and the Medicare book because of duals and between CenterWell and the Medicare book because of the ability to impact quality and total cost of care. So we actually think that combination works and we continue to lean into it. When we think about capital deployment, the simple rubric that we're kind of staring at is strategically does it align with driving lower total cost of care and/or quality? Does it offer an attractive return on capital? And when you look at the array of opportunities to invest, what drives the best return over time? Right? What drives shareholder value over time? Those are the things that we're looking at, and we're looking at the same spaces that we've been looking at it in the past. Our last question will come from the line of Ryan Langston with TD Cowen. Ryan Langston Hi. Good morning. On the inpatient activity, just in the prepared remarks, you said performing higher levels of appropriateness checks and potential mitigation activities. I guess, is there a potential maybe down the road for maybe a larger than normal amount of revisions on these claims for medical necessity or the like, or a disadvantage to those kind of claims in mass, look largely to be adjudicated as they are. And then I think you said that you were negotiating with providers for closer alignment. Can you elaborate on exactly what that means? Thanks. Susan Diamond Hey, Ryan. Yeah. I'll take the first part of that and then hand it over to Jim for the second. On the inpatient, I think as you guys are, we do within our utilization management programs, have what we call a frontend review process. So we are reviewing those authorizations in real time as they come in for things like medical necessity and site of service effectively. And as I said, those -- we did have some changes to our expectations and how those programs would impact under the new 2-midnight rule. So that is operating as intended and as we said, largely having the results we expected. There is also activity that we do after the claim comes in, which we call a postpay review, where there are some incremental opportunities to just review, again the more specificity on that claim to make sure it's appropriate and we get value from both sides of that. But I would say we have really good information and tracking of the impact those programs are having. And I would not expect a material change to happen relative to our current expectations as a result of some of those longstanding programs. James Rechtin Yeah. And then on the contracting, if you think about the way that contracting works at a high level, you're essentially aligning on a rate and you're aligning on a set of initiatives or incentives around how to manage appropriate utilization. And we have contracts that align those incentives very well. And we have contracts where there's an opportunity to improve that alignment around utilization and appropriate care. And so we are really looking at the contracts that perform best, and we're trying to figure out how you begin to move more of the network in that direction. Hey, so with that being our last question, let me just say a couple quick things. I'm going to come back to. We do feel good about where we're at mid-year. We feel good about the performance that we've seen and where that's at relative to the beginning of the year. I am going to reinforce that. We are seeing inpatient pressure. We have seen that in particular in the back half of the second quarter and now obviously a little bit into July. We're taking a cautious approach in reaffirming our $16 guidance. And we continue to feel good that we're going to have margin expansion, EPS growth heading into 2025. And so that is where we're at. We feel good. I do want to just thank our teams. They put a lot of work into getting us where we're at here at mid-year. And I continue to look forward to working with all of you on this phone call and our teams here at Humana. So thank you. This concludes today's conference call. Thank you for participating. You may now disconnect.

CCC Intelligent Solutions Holdings, Inc. (CCCS) Q2 2024 Earnings Call Transcript

Bill Warmington - Vice President, Investor Relations Githesh Ramamurthy - Chairman and Chief Executive Officer Brian Herb - Chief Financial Officer Good day and thank you for standing by. Welcome to the CCC Intelligent Solutions Second Quarter Fiscal 2024 Earnings Conference Call. [Operator Instructions] Please be advised that today's conference is being recorded. I would now like to hand the conference over to your speaker today, Bill Warmington, Vice President of Investor Relations. Please go ahead, sir. Bill Warmington Thank you, operator. Good afternoon, and thank you all for joining us today to review CCC's second quarter 2024 financial results, which we announced in the press release issued following the close of the market today. Joining me on the call are Githesh Ramamurthy, CCC's Chairman and CEO; and Brian Herb, CCC's CFO. The forward-looking statements we make today about the company's results and plans are subject to risks and uncertainties that may cause the actual results and the implementation of the company's plans to vary materially. These risks are discussed in the earnings releases available on our Investor Relations website and under the heading Risk Factors in our 2023 annual report on Form 10-K filed with the SEC. Further, these comments and the Q&A that follows are copyrighted today by CCC Intelligent Solutions Holdings, Incorporated. Any recording, retransmission or reproduction or other use of the same for profit or otherwise without prior consent of CCC is prohibited in a violation of United States copyright and other laws. Additionally, while we will provide a transcript of portions of this call, and we've approved the publishing of a transcript of this call by a third party, we take no responsibility for inaccuracies that may appear in the transcripts. Please note that the discussion on today's call includes certain non-GAAP financial measures as defined by the SEC. The company believes these non-GAAP financial measures provide useful information to management and investors regarding certain financial and business trends relating to the company's financial condition and the results of operations. A reconciliation of GAAP to non-GAAP measures is available in our earnings release that is available on our Investor Relations website. Thank you, Bill, and thanks to all of you for joining us today. I'm pleased to report that CCC delivered another quarter of strong top and bottom-line results. The second quarter of 2024, total revenue was $233 million, up 10% year-over-year and ahead of our guidance range. Adjusted EBITDA was $96 million, up 18% over the last year and also ahead of our guidance range. Our adjusted EBITDA margin was 41%. On today's call, I would like to highlight three themes that underpin how we are helping our customers, ushering a generational change in operating performance. The first is CCC's durable business model. The second is our innovation engine, which at its core has created over 300 unique AI models and the third is a view into the pace of adoption as customers transition to this next generation of CCC solutions. My first topic is CCC's durable business model. Our solid financial performance in Q2 was a result of continued new business wins, renewals and contract expansions. We also completed the successful on-schedule rollout of our full suite of auto physical damage, or APD solutions, for a top 20 insurer as they transition from multiple vendors to the CCC platform. In our insurance business, the first half of this year has seen us renew multiple clients, add a number of new logos and across a variety of incremental products across our customer base. We've also added over 600 new repair facilities so far in 2024. This growth pushed us across a major milestone. We now have over 30,000 repair facilities on the CCC platform. Our diverse customer base, broad range of mission-critical solutions and growing multisided network have helped create a business model that has both revenue predictability and margin expansion. This balanced profile has served us well as we continue to invest in AI-enabled innovation. Because of the deep decade-plus experience we have in building AI solutions, we have an infrastructure and development model that provides tremendous scale and efficiency as customer volumes ramp. To date, our customers have processed tens of millions of unique claims using a CCC AI-enabled solution. And the economic profile of these AI solutions is similar to the rest of our SaaS portfolio. We believe the scale and efficiency of our AI deployment model will be a significant competitive and economic advantage in the future. And the foundation of our durable business model is the deep trust our customers place in us to help them solve their most pressing business problems. We believe that delivering top-tier day-to-day performance, coupled with a vision and tangible pathway to innovation is the best way to build lasting relationships with customers. These principles have served us well for decades and are the key enablers to our 99% GDR and industry-leading Net Promoter Score of 83. A hallmark of our customer-focused culture is our ability to understand our customers' pain points and to design, develop and implement new solutions that address tangible problems they are facing across their businesses. While the amount of time it takes for different solutions to gain critical mass can vary, we have consistently found that demonstrable value delivery is the key to achieving successful launches with long runways for growth. And while this can sometimes make quarter-to-quarter predictions on the adoption of new solutions challenging, our conviction around tangible product ROI is what gives us the confidence to invest in game-changing solutions over the long-term and that is precisely what we're seeing across our portfolio of innovation. This leads me to my second topic, innovation. As we approach the $1 billion mark in annual revenue, it is important to note that almost all of this growth has come from innovation. Innovation that substantially improved operating performance for our customer segments. As we look forward, we believe that our investments over the last 3 years have created an exciting pipeline of new solutions with greater breadth and depth than at any time in our history. And critically, this portfolio of innovation is not meant to deliver modest incremental improvements to customers. We believe our solutions are transformational for them. And over many years, we have found that laying the foundation for transformational change yields decades long runways for growth. A good example of this is the evolution of our automotive repair platform, CCC ONE which today contributes over $400 million in annual revenue. Leveraging the power of cloud computing, we used the launch of CCC ONE to reinvent estimating and shop management and over time have added a series of industry-leading innovations to a platform that serves everyone from single-store independents to the largest multi-store operators. Our state-of-the-art CCC ONE platform has pushed thousands of software releases over the past decade and is now the trusted operating system for more than 30,000 collision repair facilities across the United States. The CCC ONE platform is the gateway to estimating, parts ordering, repair management, diagnostics, customer communications, and much more. Today, we see our decade-plus investments in AI enabling an even larger growth opportunity across the broader P&C insurance economy. While each of our customers is different, they share a common challenge in managing the rapidly increasing complexity that has become the norm in this industry. And CCC is leading the way in investing to address this challenge. Over the past decade, we have invested over $1 billion in R&D, including about $150 million in 2023, and 17% of year-to-date 2024 revenue to develop new high ROI solutions for our customers. And we work closely with our clients to help them rapidly integrate our new innovations and also navigate the change management that is sometimes needed to fully realize the benefits of these powerful innovations. For example, in November 2021, we deployed Estimate - STP, the world's first production AI that can pre-populate on qualified repairable vehicles a full line-level estimate from a photo in seconds. And today, we have over 30 insurers using this solution. While volume from revenue-generating clients in production is still just 3% of annual claims, through our deep engagement model, we have helped one top 10 carrier be on track to process nearly 20% of their repairable claims on a run rate basis through this technology. AI is now embedded in a wide variety of solutions across the entire CCC portfolio, from AI-enabled insurance solutions like First Look, Intelligent Reinspection, Impact Dynamics, and Subrogation, to repair-focused solutions like Repair Cost Predictor and Mobile Jumpstart. The recently introduced CCC Intelligent Experience Cloud, or IX Cloud for short, is designed to accelerate our customers' digital transformation journey in a way that is purpose-built to solve for the inherent complexity of the P&C insurance economy. The IX Cloud overlays a new event-driven architecture onto CCC's existing cloud applications, customer workflows, and customer and partner systems. This microservices-based approach is designed to make it faster and easier for customers to deploy new CCC solutions and will also increase the number of ways customers can use multiple CCC solutions together. Tens of billions of dollars are wasted annually across the P&C insurance economy due to administrative inefficiency, unnecessary delays, and other forms of leakage. The IX Cloud provides a step-level change to address this inefficiency. Another important point of validation for our product portfolio was our recent annual customer conference in Atlanta this past May. We heard firsthand from more than 300 customers representing insurers, repair facilities, parts providers, automotive OEMs, and other members of CCC's multi-sider network. We also had representatives from across the 200 partners in the CCC ecosystem sharing how the IX Cloud platform can help customers extend into new areas. The positive feedback we received from our product demos reinforced our confidence in the investments we're making, and I thought I'd discuss two of the exciting innovations we showed. The first of these is CCC Intelligent Reinspection, which continues the AI theme I noted earlier. Insurers receive millions of shop-written estimates each year, and while we have several tools in place to make the review of those estimates more efficient, the added complexity of vehicles requires step-change solutions to make this process as seamless as possible. With Intelligent Reinspection, AI helps insurers prioritize their review by flagging the specific individual line items that fall outside the normal rules so they can quickly engage with the shop and resolve the claim. The second is CCC Build Sheets. Vehicle complexity has gotten to a point where the number of possible replacement part options is negatively impacting ordering accuracy. Take a driver's side mirror as an example. Ten years ago, all you had to worry about was paint color. Today, the matrix of choices includes heated versus unheated, paint color versus chrome, auto folding, blind spot detection, 360-degree view camera. This creates dozens of possible combinations. Build Sheets denote the exact factory installed options on an individual vehicle as manufactured, and having access to them during estimate creation means an estimator can accurately filter to the correct replacement part from potentially dozens of available versions of that part for the exact model and make of the vehicle being repaired. We recently launched CCC Build Sheets as an add-on for CCC ONE customers so they can have this data online while they're writing the estimate. That means fewer part returns, fewer supplements, and reduced cycle time because the repair facility is writing a more accurate estimate the first time. Both of these solutions have been getting strong early interest from customers. My third and final topic is the adoption of CCC solutions. We continue to see strong demand for our solutions across our customer base, including high levels of customer engagement and pilots for new solutions, but we're also seeing the duration of pilot conversion for our emerging solutions take longer than anticipated to convert into in-year revenue. Last year, emerging solutions contributed about one point to revenue growth, and in our Q4 earnings call, we discussed our expectation that emerging solutions would contribute two points of growth in 2024. We now expect emerging solutions to continue to contribute about one point of growth in 2024, with good contributions of these solutions playing out more materially in 2025. Our confidence in the long-term opportunity from these solutions is based on the strong engagement we are having with customers and the value delivery that we see from early results. Each of our emerging solutions is being evaluated by multiple top 10 insurers, and nearly all of our top 20 insurance accounts are piloting and/or evaluating one or more of these products. Live contracted customers are also experiencing significant positive impacts to performance. Within subrogation, for example, we now have double-digit contracted customers using one or more solutions. With tens of millions of dollars of impact already realized from using our recently introduced inbound subrogation solution alone, with many more customers in active pilots. We're also seeing continued progress in adoption for Estimate - STP and diagnostics workflow, though in aggregate, the rate at which these new solutions contribute to in-year revenue has been slower than anticipated as customers have pursued larger than expected change management activities aimed at fully maximizing the value of a newer, more transformative solutions at scale. In my 30 plus years at CCC, the most exciting growth opportunities have always come on the cusp of a transformational industry change. I believe we were in a similar place today, except that the number of solutions and the transformational nature of these solutions is the greatest I have ever seen. We are investing accordingly to capitalize on this generational opportunity and are confident in our position as our customers' trusted partner of choice to help them navigate this journey. We believe doing so will deliver substantial benefits to our customers and also allow us to deliver against our strategic and financial objectives over the near and long-term. I'll now turn the call over to Brian, who will walk you through our results in more detail. As Githesh has highlighted, we are seeing strong innovation and client engagement across our solution set. We are pleased with our top and bottom line performance, which reflects a balance between investment in our growth initiatives and ongoing margin discipline. Now, as we turn to the numbers, I'd like to review our second quarter 2024 results and then provide guidance for the third quarter and full year 2024. Total revenue in the second quarter was $232.6 million, up 10% from the prior year period. Approximately 7% of our growth in Q2 was driven by cross-sell, up-sell, and adoption of our solutions across our client base, including repair shop upgrades, continued adoption of our digital solutions, and ongoing strength in casualty and parts. Approximately three points of growth came from our new logos, mostly our repair facilities and part suppliers. About one point of growth in Q2 came from our emerging solutions, mainly Diagnostics, Estimate - STP, and the new adjacent casualty solutions. Now, turning to our key metrics, software gross dollar retention, or GDR, captures the amount of revenue retained from our client base compared to the prior year period. In Q2 2024, our GDR was 99%, which is in line with last quarter. Note that since the first quarter 2020, our GDR has been between 98% and 99% and is either rounded up or down, driven primarily by repair shop industry churn. We believe our GDR reflects the value we provide and the significant benefits that accrue to our customers from participating in the broader CCC network. Our GDR is a core tenant of our predictable and resilient revenue model. Software net dollar retention, or NDR, captures the amount of cross-sell and up-sell from our existing customers compared to the prior year period, as well as volume movements in our auto physical damage client base. In Q2 2024, our NDR was 107, which is in line with Q1 2024 and consistent with our average across 2023. Now, I'll review the income statement in more detail. As a reminder, unless otherwise noted, all metrics are non-GAAP. We provide a reconciliation of GAAP to non-GAAP metrics in our press release. Adjusted gross profit in the quarter was 182 million. Adjusted gross profit margin was 78%, which is flat sequentially and up against 77% in Q2 of 2023. The stronger year-over-year adjusted gross profit margin primarily reflects operating leverage on the incremental revenue. Overall, we feel good about the operating leverage and the scalability of the business model and our ability to deliver against our long-term adjusted gross profit target of 80%. In terms of expenses, adjusted operating expense in Q2 2024 was 96 million, which is up 7% year-over-year. This was mainly driven by higher IT-related costs, as well as investment in our customer-facing functions. Adjusted EBITDA for the quarter was 96 million, up 18% year-over-year, with an adjusted EBITDA margin of 41%. Now, turning to the balance sheet and cash flow. We ended the quarter with 238 million in cash and cash equivalents, 780 million of debt. At the end of the quarter, our net leverage was 1.4x adjusted EBITDA. Free cash flow in Q2 was 36 million, compared to 55 million in the prior year period. Free cash flow on a trailing 12-month basis was 197 million, which is up 11% year-over-year. Our trailing 12-month free cash flow margin as of Q2 2024 was 22%, that is up from 20% as of Q2 a year ago. Unlevered free cash flow in Q2 was 48 million, or approximately 50% of our adjusted EBITDA. While our level of free cash flow can vary quarter-to-quarter, we expected to continue to average out in the mid-60 range of our adjusted EBITDA on an annual basis. In May, we issued 3.8 million shares to redeem 17.8 million in private sponsor awards. The transaction helped simplify our capital structure going forward. In addition, our private equity owners completed two secondary offerings since our last earning call, 50 million shares in May and 30 million shares in July. Our free float, as measured by Bloomberg, is currently over 70% of shares outstanding. That's up from about 30% in October, a significant improvement in stock liquidity over the last nine months. I'll now cover guidance beginning in Q3 2024. We expect total revenue of 236 million to 238 million, which represents 7% to 8% growth year-over-year. We expect adjusted EBITDA of 97 million to 99 million, a 41% adjusted EBITDA margin at the midpoint. For the full year 2024, we expect total revenue of 941 million to 945 million versus our previous range of 944 million to 950 million. An adjusted EBITDA of 391 million to 395 million versus our previous range of 389 million to 395 million. The midpoint of our new range represents about a half a percent reduction in year-over-year revenue growth to 9% and a half a percent increase in adjusted EBITDA margin to 42%. So three things to keep in mind as you think about our third quarter and full year guide for 2024. The first point is that, as Githesh referenced in his remarks, we expected emerging solutions to increase their contribution to revenue growth in the second half and make up about 2 percentage points of our full year 2024 revenue growth versus one point contribution in 2023. While client engagement around our emerging solutions continues to be very strong, it is taking longer to convert pilots to revenue than we had originally forecasted. As a result, we are now expecting the contribution from emerging solutions will remain at about 1% for 2024. That said, our medium to long-term view of the growth contributions from these solutions has not changed. The second point is that, as we discussed in our earnings call last year, we had a one percentage point benefit in Q3 and a one percentage point benefit in Q4 of last year from non-recurring items. One point came from catch-up revenue on a subscription contract in Q3 and one point came from one-time items in year-end true-ups in Q4 of last year. Note that our year-over-year revenue growth can be impacted by contract timing and solutions with volume components. The third point is that Q2 of this year adjusted EBITDA margin of 41.2% was up about 300 bps year-over-year. The increase was stronger than initially expected largely because of phasing of cost benefit in the first half of the year. Margin of the second half will be impacted by the pace of hiring and phasing of cost in the second half. For the full year of 2024, we expect margin expansion of about 100 basis points year-over-year to about 42% and margins for the second half of the year to expand sequentially over margins in the first half. Overall, the strong trends we're seeing in renewals, relationship expansion, and engagement around new solutions reinforces our confidence in the underlying strength of the business. The combination of our durable business model, advanced AI capabilities, interconnected network, and a broad solution set puts us in a unique position to help our customers in the P&C insurance economy reduce their cycle times and administration costs while improving their consumer experiences throughout the claims process. We are confident in our ability to deliver against our long-term target of 7% to 10% organic revenue growth and mid 40% adjusted EBITDA margin as we continue to execute on our strategic priorities and generate significant value for both our customers and our shareholders. With that, operator, we are now ready to take questions. Thank you. [Operator Instructions] And our first question is going to come from the line of Dylan Becker with William Blair. Your line is open. Please go ahead. Dylan Becker Maybe Brian, starting with you and maybe also for Githesh here. it sounds like that decisioning elongation is playing out and you called out maybe the change management aspect that's driving that. I get that there's some near-term implications there, but wondering how you guys are thinking about what that means for the long term of the business with the healthy pipeline you've called out and maybe the opportunity for that to unlock kind of incremental capacity to adopt more of the platform over time? Brian Herb Yes, sure. Dylan, it's Brian. I'll start and then Githesh can add. So, the position over the medium to long-term is not changing. We've talked about the emerging solutions and how they will contribute to the long-term growth target. We still feel very strong and confident about that position. We talked about them scaling to about three to four points of growth within the long-term target, and we still believe that that is a good target and we're confident that we'll move towards that over time. Githesh Ramamurthy Yes. The one thing I would add to that is the number of customers, I think, as we pointed out in, if you look at our top 20 carriers, whether they're evaluating, testing one or multiple solutions, so it's very, very healthy in terms of the energy our customers are spending. But more, perhaps even more important than that is the ROI and the impact that we're seeing in these solutions are substantial. And so, to the point you made about change management, where what we see is customers putting even more focus saying, I can see some significant impact, so maybe I make more process changes or changes to take advantage of the solutions. So, that is taking a little bit longer. Dylan Becker Okay. Great. That's really helpful. Maybe for Githesh here too, you called out kind of the innovation engine here and hard not to notice what seems to be kind of continued acceleration on product rollouts. Given you do offer so much value and it's pretty tangible and there's room for continued adoption, how should we think about kind of that potential product roadmap as well and how much more white spaces are out there that you guys can potentially solve or digitize from that workflow perspective? Thanks. Githesh Ramamurthy So, if you step back and we started this effort, as you may recall, about two to three years ago, we said we'll continue to make sure that our core business continues to perform, continue to increase profitability of the business. But at the same time, we said we'd increase the velocity and delivery of new solutions. And a lot of it is stemming from our core AI capability that we've started building up a decade ago. So, what we see from these solutions that we've introduced, whether you call it in the last six months, last two years, that TAM for these solutions is in that $2 billion range. So, if you think about the expansion opportunity for these solutions is in that $2 billion TAM range. Our next question comes from the line of Alexei Gogolev with JPMorgan. Your line is open. Please go ahead. Alexei Gogolev I realize that you already mentioned that there is no direct impact on CCCS from CrowdStrike outage. But can you elaborate how some of your big clients are impacted from the event? And would you agree that the companies in your industry that are having the biggest issues are the ones that don't have their arms around their infrastructure? Do you think this outage can trigger broader issues for your customer base? Githesh Ramamurthy Alexei, thank you for the question. I would say that exactly as you pointed out, there's been no impact on our business because we do not use CrowdStrike. And as you know, we're also in the public cloud. So, with the one incident that we talked about, we immediately disconnected from that one provider who had the problem. And so, we disconnected all the interfaces. So, that caused, honestly, a little bit of disruption for several weeks as it impacted some of the parts ordering that is done from dealers out of the dealer management systems. It caused the impact for some, some about 10% of our repair facilities are owned by dealers and also parts ordering. I would say for our insurance customers, for the most part, there was almost minimal to no impact whatsoever. So, that's the answer to your question, Alexei. Alexei Gogolev Thank you, Githesh. Have you seen any incremental growth from IX Cloud, i.e., are customers placing more of their operations on CCC because of this increased connectivity? Githesh Ramamurthy We are seeing that more customers are now working to integrate more solutions. IX Cloud accelerates that ability to implement more solutions together. For example, if you look at solutions like Estimate - STP, working with First Look, working with Impact Dynamics, so these are examples where multiple solutions can work better and closer together, and IX Cloud helps with that, and we are seeing customers also excited about that. Our next question comes from the line of Samad Samana with Jefferies. Your line is open. Please go ahead. Samad Samana Maybe first, just on the emerging solutions taking longer to go from pilot to conversion. Straightforward there, I guess, Brian, my question would be, should we then assume that we'll track closer just over time to assume the lower end of the long-term target range as well as long as is it's taking longer, or is this something that you view as transitory? I'm just trying to recalibrate what we should assume not just for the rest of this year, but maybe how you want us to think about it on a go-forward basis, that pilot to conversion timeline? Brian Herb Yes. Hey, Samad. It's Brian. Thanks for the question. Yes. I mean we're setting the guide in the second half of the year in a place we're comfortable and confident on based on the reset on emerging and the time. When we think about 25 next year, we are expecting more material contribution off emerging. So, we do see it continuing to step up going into next year. We're not going to get specific within the guide, but we are very comfortable with the long-term range that we've put out in the market. Dylan Becker Great. And then Githesh, maybe a follow-up for you. It's a big number, the one customer that you referenced that's processing 20% on a run rate basis of their claims using one of the AI solutions. I guess I was seeing if you could give us maybe some more information there in terms of how are they defining the ROI that they're seeing by processing that high percentage of volume. And then, has there been any kind of consequent change to the economics of their contract and what that looks like versus a typical CCCS customer and would it benefit you? Githesh Ramamurthy Sure. So, let me just first talk about the customer themselves. So, this customer actually implemented our AI, Estimate - STP, and its precursor in late 2021. That's when they really started. So, they started out going to about a few states, expanded to multiple states, and then expanded to multiple vehicle types and continued and then moved to about 50 states. And as they got more and more comfortable with the solution and the AI and the precision, the accuracy of the AI, and most importantly, the two things the solution was doing is handling consistency and complexity of new vehicles that were coming in. So, they were starting to see that in many instances, hate to get mathematical on you, but the bell curve, you've got a much narrower distribution in terms of how they were dealing with it. And they started to apply the solution to different mixes of their book across different states and the results continue to be really good. So, on a run rate basis, they are now tracking towards 20%. Our entire customer base in aggregate is tracking towards that 3%. But this is a top 10 carrier who now has three years of experience and is now tracking towards that 20%. And they're very excited about the results. And then in terms of contracts, obviously, there's an incremental amount of revenue that comes out of this solution being fully deployed. But we don't break out any individual customers, as you know. Our next question comes from the line of Saket Kalia with Barclays. Your line is open. Please go ahead. Saket Kalia Githesh, maybe to start with you, the explanation around emerging solutions was pretty straightforward in terms of timing and RevRec. Can you just maybe go one level deeper and talk about whether any specific emerging solutions was maybe seeing more of the scrutiny? Was it Estimate - STP, for example, that customers were maybe evaluating for a longer time? Or was it diagnostics or subrogation? It sounds like it was in the aggregate, but maybe you could go one level deeper and speak to which part of the emerging portfolio maybe saw that additional kind of time. Githesh Ramamurthy Yes. I think there are slight differences between each one of them are slightly different, given the nuances. So rather than to go through all of them, I'll just pick one as an example, and I'll pick on Subrogation as an example for you. So subrogation is one where we literally have at this stage double-digit customers in contract. And what we're seeing with subrogation, back to the value proposition, is that we saw an 80% decrease in cycle time. This is for inbound subrogation. Notice that outbound subrogation still not fully rolled out. So this is for inbound subrogation. And these customers have processed tens of millions of dollars and have seen tens of millions of dollars of improvement. And the impact on accuracy or how the demand dollars are coming in and how they're responding, that increase has been somewhere between 20% and 50%. So substantial impact, significant cycle time improvements. So this is an example where the customers have said, we are excited about what we're seeing. Sometimes we've had decentralized or distributor teams. With this solution, we can centralize the teams. There's more change management we can execute, and there's more that we can do, but it requires some level of training, reorganizing to capture the opportunities that are in front of us. So this is an example of just picking one solution, and each one has slightly different nuances. And by the way, in addition to the double-digit customer base, we also have a long list of customers also evaluating, piloting, testing. And the early references from these customers, I think some of this might even be public, but the early references from the customers is also helping with newer customers who are piloting and testing. So we feel very good about that. Does that answer your question? Saket Kalia Yes, it does. It does. It definitely gives it more color. Brian, maybe the follow-up for you, at one point of growth, I mean, clearly the emerging solutions are still scaling. And so maybe this is going to be an unfair question to ask, but how do you sort of think about, even just anecdotally, the margin differences between the big scale established solutions versus emerging? Because of course, with the revenue guide just maybe getting adjusted a little bit, it was good to see the EBITDA guide go up a little bit. Maybe just talk to the margin differences between established versus emerging to the extent you can. Brian Herb Yes, absolutely. I would say, I mean, we start at where we're going to get to. When these products are mature and they're at scale, they will have a similar margin profile as our established and core solutions. And we are seeing efficiency in the AI. So there's nothing at a margin level that will really look different than our current solutions today when they get to scale. We are seeing early stage costs that will be different on them before they scale. We have set up costs. The amortization starts to come through cost of revenue when we launch the product and it's open for GA. So there is some cost that gets in front of the revenue. And then once the revenue gets to scale and gets to a tipping point, the margin profile will be consistent with the broader margin profile of CCC. So that's how to think about it. I would just say, in general, we're happy with where margins are. The first half had close to 300 basis points of margin improvement. And we're guiding to a full year of around 100 basis points of margin improvement. And our next question is going to come from the line of Gabriela Borges with Goldman Sachs. Your line is open. Please go ahead. Gabriela Borges Githesh, I would welcome your perspective here. At any time in the last 40 years, we could have made the argument that the portfolio is split between more established products and newer emerging products. So help us understand what's different this time to how you're thinking about the forecasting and the adoption of emerging products? Or do you just think that at any given time you have a mix in your portfolio between more established and ramping? Githesh Ramamurthy Hey, Gabriela. Sure. As you can imagine, from my perspective, right, 90% of the revenue we just reported, we're almost up to a billion dollars in revenue. And 90% of this revenue we reported started at zero, right? So very little of this has come through acquisition. So we have, back to your 20-year perspective, almost all of these products have come essentially from zero. So the pattern recognition we have around this is really a handful of some very, very fundamental things, which is what is the ROI? What's the impact? What are we seeing? So this is also, as I pointed out, unlike here's some core differences between what we've seen to your question about what we've seen over 20 years, where we are today. But two or three fundamental differences. One, we are now 10 years of execution and development on AI. And the range of solutions we can deliver using our AI are very different from solutions that we could have ever delivered through traditional deterministic software development. So the solutions themselves are different in nature. The ROI is very strong. The second thing I would say is very different is that I cannot recall at any point in our history where the breadth of our products, if you look at what we've delivered for insurance in terms of our insurance customers, from Estimate - STP to First Look, Impact Dynamics, Intelligent Reinspection, Subrogation, extensions to casualty, and then same thing with our repair facility customers, where we have a whole series of new solutions. The breadth of the solutions we have and the solutions' abilities to work with each other and deliver greater impact, that's the second thing that is fundamentally different. The third thing I would say is different is that our customers went through an exogenous shock in the 22, 23 timeframe. So when you looked at our customers' profitability, especially our insurance customers' profitability, '22 and '23 were years where inflation cost of parts, inflation in claims costs were substantial. And many of our customers went through some fairly tough challenges. And then as that started to correct itself into early 2024, what we're seeing from our customers is that they're saying that we would rather go bigger in terms of making changes and get ready for a broader, bigger set of changes, as opposed to incremental changes. Because if you make incremental changes and the situation like '22 or '23 repeats itself, then it is a real problem. So the changes that our customers have undergone is leaning them and causing them to think bigger and broader and bolder changes, which we are excited about. And that's why we also said almost every one of our top 20 customers, carriers, are testing one or multiple solutions with us right now. Gabriela, did that answer your question? Gabriela Borges Yes, yes. Very much. Githesh, when you talk about bigger transformational changes, to me that also signals longer-term changes, which seems consistent with what you're saying. I'm not sure if that longer-term time frame is tied to perhaps the technology needing to be iterated upon more. So to what extent a customer is saying, well, we can see the potential that these particular products have. But from a road map standpoint, we're even more enthusiastic to see what it looks like a year from now. So maybe is that creating a little bit of a pause as well? Help us understand that dynamic. Githesh Ramamurthy Yes. I would parse that question slightly differently. So what we are seeing, this is why I gave the subrogation example. So what we're seeing is, first of all, to be very blunt, initially there's skepticism, right? How is it possible that the AI and a whole new set of tools can do things very dramatically differently from what has been possible before? And once people start putting it, using it, and see numbers like an 80% decrease in cycle time, a 20% to 50% increase in accuracy, what that says is, it's not that people need longer times to prove it out, because you can see those results literally in 90 days, because we have integration, we're cloud-based, you can see all of that. What people are now coming back and saying, in order to fully maximize the capability this thing offers, if I make adjustments to the way my staff, my process flows are structured, I can capture more of these capabilities, and I can train people differently, and that is where we are seeing the lengthening of time. And our next question comes from the line of Shlomo Rosenbaum with Stifel. Your line is open. Please go ahead. Shlomo Rosenbaum Just to confirm, everything that we're talking about here is emerging solutions. Are there any changes at all in terms of sales cycles or the market environment or anything on, the legacy, I guess, you call it the vast majority of the business that you guys are working on. And then afterwards, maybe for Brian, maybe you could talk a little bit about what you did with the warrant liabilities in terms of getting them off the balance sheet and whether that affects the trajectory of the share creep? Brian Herb Yes. Shlomo. I'll cover the warrant one first because it's straightforward. Yes, we converted the remaining warrants. So there was private sponsor warrants. There's about 17.8 million of those. We converted them to shares. There's about 3.8 million shares that we issued. Those are now in the outstanding count, and so that cleaned up the cap table. So we were happy with that and be able to close the door on having warrants in the cap table. On your first question regarding the established solutions in the core, when you look at what the second half guide is highlighting, the only change that's playing through the numbers is the emerging solutions reducing the second half. Outside of that, the second half position is consistent with the prior guide. So we're feeling good on the established solutions. We have good pipeline and strong momentum. And so overall, we're happy with the performance in the core. Our next question comes from the line of Chris Moore with CJS Securities. Your line is open. Please go ahead. Chris Moore I will leave the emerging solutions alone. I just maybe want to talk about one that I get from clients a lot is on the stock comp side. Just as a percentage of revenue, it looks like it's down a bit, but still above that 10% to 12% to 14% of revenue that you talk about. Can you talk to that a little bit? And I know it just can jump around a little bit. Just any kind of further thoughts on the normalization? Brian Herb Yes. Chris, it's Brian. Yes. So in the quarter, Q2 was 17%, which is down slightly from Q1. We do expect to continue to move down as we go through the year. The one thing that's pushing it up is there is a modification to the TSRs that happened at the end of last year. And there's about a $67 million P&L impact with that change. And that largely runs through this year. When that runs out and we get into next year, it's going to look like the more normalized run rate. And that will be about 12% to 14% on a run rate. So that's the way to think about the run rate. The modification on the TSR, maybe just one other point, is there was no impact on shares being issued. It was an accounting P&L charge. And that's really the only impact that's run through the numbers. The next question comes from the line of Gary Prestopino with Barrington Research. Your line is open. Please go ahead. Gary Prestopino I'm interested in this new product you launched, Build Sheets. I mean, are you the first one out there with something of this nature? And how far is that in terms of model years does this go for the vehicles that are out there? Githesh Ramamurthy Just to clarify, are you talking about Build Sheets? Okay. I believe, I'm not 100% certain, but I believe we are the first ones with Build Sheets at the repair facility level integrated, again, not 100% sure of that. What is really powerful about this is it goes back many, many years, and we actually have done extensive work in making sure that Build Sheets have been integrated. So first of all, you're familiar, Gary, with our total loss solutions and other solutions where we actually have integrated Build Sheets into those capabilities, but it's the first time it's being introduced to the repair facility market, and it covers the vast majority of all brands and goes back many, many years And yes, so that's basically the gist of it. Gary Prestopino I mean do you feel that this has the potential to become a fairly significant product you need on the repair side? Githesh Ramamurthy Yes. The early receptivity of what we've seen in the first 60 days has been pretty substantial in terms of uptake. It's also a solution where customers can essentially self-service, go on the website, a couple of clicks, add it. And it has a pretty dramatic impact on simplification of the estimates and what you're ordering. What it does is it continues the trajectory of CCC ONE. You go way back with us, and if you remember, CCC ONE started at almost nothing. It's well north of $400 million today, and this continues to add to that trajectory of solutions. Gary Prestopino And then just one last question on this product. I mean the data, do you get it from the manufacturers? Or is this the data that you've been accumulating in-house over the years that gives you the ability to produce these kind of Build Sheets? Githesh Ramamurthy Without going into all the gory details, we would say that there's a variety of sources. And this is extraordinarily important to have actual manufactured data so that the options as the car came off the manufacturing line, is down to that particular VIN number. So you're not chasing down 35 different types of mirrors and you're getting the one mirror because that really affects parts ordering and cycle time. Our next question comes from the line of Josh Baer with Morgan Stanley. Your line is open. Please go ahead. Unidentified Analyst Great. This is [indiscernible] tonight for Josh Baer. Maybe just more philosophically on margins. EBITDA upside was strong in the quarter against previous messaging for Q2 being that kind of low point in the year on margins. Impressive to see you move those up for the full year even with revenue coming down slightly. I guess, through this lens, kind of looking across the model, where are you seeing the most leverage? And looking ahead, is there further room for leverage in these areas? Just kind of speaking to the durability in these areas as it relates to margin expansion would be helpful. Thanks a lot. Brian Herb Yes, absolutely. Yes. No, we feel good on the EBITDA position in the margin, and we did take up the midpoint within the updated guide really on the strength we're seeing in the business. To your point on the sequential or seasonal components, we did have some cost phasing that benefited us in Q2 which helped the position, and that has some offset in the second half. And so that's why the margins have moved around a little bit, H1 to H2. But we did strengthen the guide for the full year. We see leverage across cost of revenue. We expect right now, gross profit is about 78%. We expect that to move more like 80% over time. And we see good leverage in sales and marketing and G&A. Revenue will continue to grow over those cost areas. R&D will be the fastest-growing cost category over time, but we still believe there's leverage there as well. And we are seeing efficiency as we scale AI across our solutions, and so that will be helpful on the margins playing out over time as well. Our next question comes from the line of Tyler Radke with Citi. Your line is open. Please go ahead. Unidentified Analyst Hey. It's Peter on the line for Tyler Radke. Thanks for taking the question. So you had called out that insurers are undertaking a large transformative architecture changes. Could you give a little bit more into detail on what those changes are that are slowing down the pace of emerging solution adoption, and then why is that a current trend given like the strong pricing and market condition in P&C? Thanks. Githesh Ramamurthy Yes. These are not architecture changes. These are more operational changes to become much more efficient. That's really what we're talking about. Unidentified Analyst Okay. And then on your new solution to Intelligent Reinspection, just interested how you expect the adoption curve of that to play out. And then, could you give us an idea like where this stacks up on importance for customers looking to adopt new CCC solutions? Githesh Ramamurthy Sure. So what this solution does is, I think there's a release out there today, and it speeds up the whole process of doing reviews for literally tens of billions of dollars of collision repairs that insurers are working on their repair networks. And what this does is that the AI is actually looks at the carriers' rules and can speed up a lot of the decision process, because the AI can be quite detailed and look at a lot of the nuances and essentially helping speed up and not hold up repair facilities to give approvals quicker and do a lot of those things. And so the heart of it, you've got tens of billions of dollars of repair that between getting assignments, going to repair facilities, repairs being completed, payments being made. So you've got all of that going back and forth. So the nice thing about this solution is we have a previous version of this solution that's been there for a very long period of time. This is a step function change in the solution, and it can be implemented essentially in line with the existing workflows, no change to existing workflows, no change to integration and people can start using it right away and immediately. And the early feedback from customers who are testing it has been absolutely fantastic. And these are some of our largest customers who are testing it. Thank you. I would now like to turn the conference back to CEO, Githesh Ramamurthy, for closing remarks. Githesh Ramamurthy Thank you all for joining us today. And as you can probably see, the durability of our business model continues to come through, and we remain confident in our ability to deliver on our strategic and financial objectives. While at the same time, truly helping our customers in the transformative journey going forward. And this week also marks our 3-year anniversary of returning to the public markets, a very important milestone in our journey as a public company, and I'd really like to take this opportunity to thank our customers, our shareholders and all our CCCers for the tremendous work they do day in and day out, and we look forward to keeping you updated. Thank you so much. This concludes today's conference call. Thank you for participating. You may now disconnect.

Brixmor Property Group Inc. (BRX) Q2 2024 Earnings Call Transcript

Stacy Slater - Senior Vice President-Investor Relations and Capital Markets Jim Taylor - Chief Executive Officer Brian Finnegan - President and Chief Operating Officer Steve Gallagher - Executive Vice President and Chief Financial Officer Mark Horgan - Executive Vice President and Chief Investment Officer Welcome to the Brixmor Property Group Second Quarter 2024 Earnings Conference Call. At this time, all participants are in a listen-only mode. A question-and-answer session will follow the formal presentation. [Operator Instructions] As a reminder, this conference is being recorded. I would now like to turn the call over to Stacy Slater, SVP of Investor Relations and Capital Markets. Thank you. You may begin. Stacy Slater Thank you, operator, and thank you all for joining Brixmor's second quarter conference call. With me on the call today are Jim Taylor, Chief Executive Officer; Brian Finnegan, President and Chief Operating Officer; and Steve Gallagher, Executive Vice President and Chief Financial Officer; Mark Horgan, Executive Vice President and Chief Investment Officer, will also be available for Q&A. Before we begin, let me remind everyone that some of our comments today may contain forward-looking statements that are based on certain assumptions and are subject to inherent risks and uncertainties as described in our SEC filings, and actual future results may differ materially. We assume no obligation to update any forward-looking statements. Also, we will refer today to certain non-GAAP financial measures. Further information regarding our use of these measures and reconciliations of these measures to our GAAP results are available in the earnings release and supplemental disclosure on the Investor Relations portion of our website. Given the number of participants on the call, we kindly ask that you limit your questions to one or two per person. If you have additional questions regarding the quarter, please re-queue. At this time, it's my pleasure to introduce Jim Taylor. Jim Taylor Thanks, Stacy, and good morning, everyone. Before speaking to our results and continued execution, I'd like to begin by congratulating Brian, Steven, Kevin and Helane on their well-deserved promotions. Simply put, well done. As a company, our foundational cultural tenant is that great real estate matters but great people matter even more. At Brixmor, we are blessed with the best team in the industry, a team that continues to deliver outperformance quarter in and quarter out, as we execute our balanced value-added plan. Speaking of records, we achieved record occupancy and record new and renewal spreads in the quarter. Once again, highlighting the flywheel effect of our portfolio transformation and our ability to capitalize on the embedded mark-to-market opportunity. In fact, we average rents of $23.82 a foot versus our average in place of $17.25. Importantly, we also commenced an additional $17 million of ABR in the quarter, ahead of expectations, while our signed but not commenced ABR, replenished to $65 million. Again, providing excellent visibility on continued top line growth as those leases commence paying rent over the next several quarters. Overall, that top line revenue growth drove most of our same-store performance of 5.5% in the quarter as growth in operating margins, driven largely by increased occupancy and penetration of fixed CAM delivered the balance of that growth. That same-store growth, in turn, drove bottom line FFO growth of nearly 6% in the quarter when you exclude the prior year gain on debt extinguishment. Even with expectations of higher levels of bad debt and lower prior year recoveries as Steve will detail further in a moment. This outperformance led us to raise our FFO guidance to a range of $2.11 to $2.14, an increase of $0.03 at the midpoint. On the reinvestment front, we continue to make excellent progress, delivering $37 million at an incremental return of 9%, putting us on track to deliver over $200 million for the full year. We also commenced $100 million of pre-leased reinvestment projects, including a second phase at Pointe Orlando, in an exciting restaurant out parcel district called Block 59 in Naperville that Brian will discuss further. These and other projects underway provide us with excellent visibility that we will continue to deliver $150 million to $200 million per our plan in 2025 and 2026 and beyond. On the capital recycling front, we closed during the quarter on a $17 million acquisition in Long Island that is immediately adjacent to one of our existing centers. And just barely a month into ownership, we've identified several groceries to backfill an empty box at highly accretive rents. With these and other grocery opportunities that Brian will highlight in a moment, we continue to organically grow our overall grocery-anchored percentage to over 80% of ABR. Importantly in a manner that unlocks huge value through yield and compression and cap rate. Following quarter-end, we also closed on the acquisition of Fresh Market Shoppes in Hilton Head, a value-added acquisition that builds on our critical mass in the fast-growing coastal Carolinas market. Further, our forward acquisition pipeline continues to build to over $200 million with opportunities in our core markets to further cluster and leverage our best-in-class platform. Finally, I'm pleased to report that we continue to demonstrate the strength of our balance sheet and the impact of our balanced strategy as we brought debt-to-EBITDA down to 5.6x and have over $1.7 billion of liquidity to fund our business for the next several years. In sum, our balanced value-added business plan not only continues to deliver on all fronts, but also positions us importantly for continued outperformance. With that, I'll turn the call over to Brian for a more detailed discussion of our operating results. Brian? Brian Finnegan Thanks, Jim, and good morning, everyone. I'm pleased to report another quarter of outstanding operating results delivered by the Brixmor team as demand to be in our centers from a wide range of high quality operators shows no signs of slowing down. The well-capitalized tenants we are attracting and the rents we are achieving demonstrate not only the continued transformation of our portfolio but the unmatched strength of the Brixmor platform. Our leasing activity during the quarter allowed us to achieve records once again in overall anchor and small shop occupancy with small shops growing sequentially for the 14th consecutive quarter to 90.8%. Record occupancy levels are also enabling our team to push rental rates higher in both new and renewal leases, which was also evident in our results as we achieved record renewal growth of 19% across 195 renewal leases executed in the quarter to pair with the over 50% growth in our comparable new leases, which Jim highlighted. As encouraging as these results are, what's even more encouraging are the tenants we deliver them with. Tenants like Ulta, HomeGoods, Rally House, Skechers and Boot Barn, along with the company's first new lease with Wayfair in Greensboro, North Carolina, yet another online retailer that is recognizing the importance of having a physical store footprint. We also continued to grow our grocery-anchored percentage during the quarter. Adding another Sprouts Farmers Market to proactively backfill a Conn's location in Knoxville, Tennessee at close to triple the in-place rent, demonstrating once again the opportunity that we have in our below-market leases and the speed at which our team can capitalize on them. The Conn's boxes are among the few that are expected to come back to us at a time when box vacancy is at historic lows for the portfolio. And our team is well on their way to backfilling these spaces in markets like Raleigh and Houston with better tenants at higher rents. Briefly on reinvestment to expand on what Jim highlighted, we are very excited to bring on $100 million of accretive pre-leased transformative redevelopment projects during the quarter, led by the second phase at Pointe Orlando and Block 59 in suburban Chicago. Phase 2 of Pointe Orlando is coming online at the perfect time as we prepare to open live at the point in partnership with the Cordish Companies later this fall, and Block 59 includes a great mix of well-capitalized restaurant tenants complementing the grocery-anchored component of the shopping center in one of the most desirable suburbs in the Chicago market. Looking forward, we remain encouraged by the depth of retailer demand, and the forward and legal pipeline, which continues to grow despite the records we continue to set in occupancy. Our team continues to be laser focused on quickly converting this demand into open rent-paying tenants which as Steve will highlight further gives us great visibility on future growth. Before handing the call over to Steve, I would like to congratulate him, Helane and Kevin on their well-deserved promotions. And thank Jim and the Board for the opportunity to serve as President as well as the broader Brixmor team for their continued support. There has never been a better time to be at Brixmor, and I'm grateful to work with the best team in the business. Steve? Steve Gallagher Thanks, Brian. I'm pleased to report on another very strong quarter and improved forward outlook, reflecting the strength of our business plan execution and the compelling growth opportunity within the Brixmor portfolio. NAREIT FFO was $0.54 per share in the second quarter, driven by same-property NOI growth of 5.5%. Base rent growth contributed 380 basis points to same-property NOI growth this quarter, reflecting continued strong leasing spreads, growth in build occupancy and improved retention rates. In addition, net expense reimbursements contributed 140 basis points driven by the growth in build occupancy and a decrease in real estate tax expense primarily due to reduced bills in our Chicago market. Revenues deemed uncollectible contributed 20 basis points to property NOI growth due to higher collection rates and lower tenant disruption. We are very pleased with the continued execution by the entire Brixmor team as we ended the quarter with a 400 basis point spread between leased and build occupancy, and our signed but not commenced pool totaled $65 million, which includes $55 million of net new rent. The size of the pool decreased only $3 million despite commencing approximately $17 million of annualized base rent in the quarter. We expect the vast majority of ABR and signed but not commenced pool to commence over the next 18 months. From a balance sheet perspective, we repaid $300 million of our 3.65% bonds that matured in June 2024 with the proceeds from our January bond offering. At June 30, we had total liquidity of $1.7 billion, and our debt-to-EBITDA on a current quarter annualized basis was 5.6x, leaving us well positioned to execute on our business plan and with the flexibility to opportunistically access the capital markets. In terms of our forward outlook, given the continued strength in the portfolio, we have increased our same-property NOI growth to a range of 4.25% to 5%, comprised of a 425 to 475 basis point contribution from base rent as commencements from the signed but not commenced pool accelerates base rent growth in the second half of the year. Additionally, the improvements to the credit quality of our tenants and strong payment trends continues to drive outperformance in revenue deemed uncollectible. We now expect revenues deemed collectible to end the year at 50 to 75 basis points of total revenues versus the prior range of 75 to 110 basis points. In conjunction with the increase in our same property NOI expectation, we have raised our guidance for 2024 NAREIT FFO to a range of $2.11 to $2.14 per share. I would like to thank Jim and the Board for the CFO opportunity as well as the larger Brixmor team who supported me along the way. And with that, I'll turn the call over to the operator for Q&A. Thank you. At this time, we'll be conducting a question-and-answer session. [Operator Instructions] Our first question has come from the line of Todd Thomas with KeyBanc Capital Markets. Please proceed with your questions. Todd Thomas Hi, thanks. Good morning, and congrats to everyone on their promotions. First question, I just wanted to ask about acquisitions. I'm wondering if there's any change in view around acquisitions and the company's position toward capital recycling and/or capital raising at all here as we move forward, just either given some of the changes in the C-suite and/or given the improvement in the company's cost of capital more recently? Jim Taylor I think, Todd, it's Jim. I think the big change has been, honestly, the opportunities that we're seeing. So we're always going to be opportunistic and direct our activity to those that we think can create huge value for the company. And we're pleased with what we're seeing out there in the transaction market, particularly in our core markets where we've successfully clustered investments, for example, we mentioned the acquisition of the Fresh Market in Hilton Head, which further grows our presence in that coastal Carolina market. So we're pleased with the opportunities that we're seeing and our ability to execute on. Todd Thomas Do you anticipate being a net acquirer in the second half of the year? And can you talk about sort of the going in yields that you're seeing for acquisitions that you're underwriting today? Brian Finnegan Yes. Look, as Jim mentioned, we're always going to be opportunistic with respect to acquisitions. And we're certainly seeing a much more active market over the last few months. Frankly, what's most interesting about the transactions market today is that sellers really appear to be more interested in kind of quiet direct conversations with folks like Brixmor that aren't relying upon external joint venture capital or, frankly, even the debt market to source deals or finance deals. Those ramp activity that you're seeing us with a couple of acquisitions we made this year really is leading to a more active pipeline on the acquisition side. So we do expect to be a bit more acquisitive here in the second half. But as Jim has mentioned over the years, we will always be balanced in discipline with respect to our capital allocation on acquisitions. With respect to yields, year-to-date, the deals where we bought is in the high-6s as we look at our forward opportunities from going in perspective, they are in the same yield, so that high-6 cap rate range. But also when you think about our cap recycling, what's important to realize is we are a whole IRR type investor. So we look at assets we sold we're seeing a pretty big spread between those IRRs on what we're selling and the IRRs for the assets that we're acquiring. Todd Thomas Okay. That's helpful. And Steve, real quick, in terms of the net recoveries related to the lower property taxes in the quarter that you mentioned, how much of that was sort of one-time in nature versus what might be more recurring as we think about lower property taxes potentially going forward? Steve Gallagher Yes. I think when you look - think about the total impact of the quarter, about $1 million of it related sort of the way Chicago builds is in arrears related to 2023. So that's sort of the non-recurring aspect. But about $0.5 million will recur in the year and then recur going forward. And I think the important thing to remember with that is, ultimately, it's lowering our occupancy cost to our tenants and will allow us to push rent on those renewals in the future. Todd Thomas Okay. That's helpful. $0.5 million in the year or $0.5 million in the quarter an annualized basis... Yes. Todd, the only other thing I would highlight there is, we're benefiting also from higher recovery rates as our occupancy, our build occupancy moves up. So while we did benefit in the quarter from the favorable tax assessments, you should expect is as we continue to drive build occupancy, recover more and generate better margins. Thank you. Our next question comes from the line of Dori Kesten with Wells Fargo. Please proceed with your questions. Dori Kesten Thanks. Good morning. Again, congrats on the promotions. Can you give us a sense of any incremental G&A that may come along with those two? Jim Taylor On balance, we don't expect incremental G&A as we look for other efficiencies. Dori Kesten Okay. And then on Conn's and Big Lots, what kind of retailers have shown interest in those spaces and where may rent spreads pencil out? And just anything irregular to note about potential TI or timing to backfill? Brian Finnegan Dori, hey, this is Brian. Just as it relates to the Conn's first, it's a pretty low exposure for us about 30 basis points. And as I talked about, these boxes may come back to us in the tightest supply environment that we've seen. And the types of tenants that we're backfilling them with are the types of tenants that continue to expand in the open-air space like those in the value apparel segment, sorry, in the specialty grocery segment, like the first Conn's that we proactively took back where we were able to put Sprouts in and tripled the rent. As it relates to the Big Lots rents, in particular, those rents are just below $8 a foot. We've been signing those - we've been signing anchor leases around $16 a foot over the past year. And you can expect a similar level of upside, maybe not double, but particularly, we got a significant amount as it relates to those Big Lots spaces. So we feel very encouraged as again, we're not getting a lot of box spaces back and is the tightest box supply environment that we've seen in terms of our ability to quickly address them to the extent we get a few boxes back this year. Thank you. Our next question has come from the line of Craig Mailman with Citi. Please proceed with your questions. Craig Mailman Hey, good morning, and congrats again, everyone, on the promotions. Jim, I just want to go back to your kind of the end of Todd's questioning on NOI margins there. I know you guys ticked up to about 76%, but you guys are getting, every quarter, it seems like another record on leased occupancy for anchors and small shop. Just as the portfolio continues to grow, you guys pushed through some fixed CAM, you get some better outcomes on tax appeals. Where do you think NOI margin should shake out for your portfolio over the next year or two as this new pipeline commences? Like what's a good normalized level to think about? Jim Taylor Rather than giving you a specific guidance on a margin, I think we've got a few hundred basis points of room. And I think you're going to see us continue to realize that, as you point out, as our build occupancy grows because there is a 400 basis point difference between leased and build. So as that occupancy delivers, obviously, we're going to be recovering a higher and higher percentage which, as you also mentioned is augmented by the increased penetration of fixed CAM that we have in the portfolio. So I do expect to see continued growth in margin I think we have more than a few hundred basis points of room I'd rather not give you a specific number for guidance. Brian Finnegan And Craig, I would just add, our team has been very intentional in terms of improving CAM clauses in our leases eliminating CAM caps, eliminating carve-outs. You mentioned fixed CAM. We've been very intentional with that as well where we've been deploying that across the portfolio. We've been - we have a good understanding of where the expense trajectory is at those properties. We've been growing that at 4% across both small shop and anchors. So in addition to everything we're doing on the base rent front, our team has been very intentional in terms of improving those CAM clauses, which is really helping with margins as well. Mark Horgan And Craig, the last thing I would add is we look at acquisitions, the whole - when we think about acquisitions, we do buy from a lot of folks who are not large institutional owners like we are, they don't have the ability to hit some of those margin topics that Brian's hitting on. So we think that's also a piece of the growth in deals that we buy on the acquisition side. Craig Mailman That's helpful. And then maybe sticking on the acquisition side on Mark or Jim, it sounds like more of the kind of pipeline you guys have gotten recently is off market or softly marketed deals. Is that - am I reading into that correctly and you guys are kind of less of the buyer for the fully marketed deals, and that's where you're going to get kind of the better opportunities to not compete with maybe some of the high net worth guys or other people who are just all cash buyers and have been paying kind of bigger prices more recently? Jim Taylor We continue to see a mix of deals marketed and off-market. I think Mark's point, though, is that we are a preferred buyer in this capital markets environment given our liquidity, given our presence in the markets that we're focused on, and that gives us an advantage position. And we're also pleased by the just growth in the overall pipeline of opportunities that we're seeing that meet our return hurdles. Thank you. Our next question is come from the line of Greg McGinniss with Scotiabank. Please proceed with your questions. Greg McGinniss Hey, good morning. So leasing obviously remains quite healthy, but there are certain tenant categories facing some pressure like home goods and art, pet and office supply. Are you still renewing tenants in that category? Or how are you handling those expirations when they come up? Brian Finnegan Yes. Greg, hey, this is Brian. I mean, we look at these on an individual basis. Our - for instance, our office supply exposure overall has dropped considerably. There still are office supply locations that are doing very well that are four-wall EBITDA positive in our portfolio. So some of those do renew, but if you think about some of the Staples locations in particular that we've taken back proactively and backfill with the likes of Ross and Grocers and other folks that we've been doing a lot of business with. So it's really going to be center specific. We've got a number of our pet store locations that continue to do very well. And I think in this environment, we're going to continue to be opportunistic where we see weaker tenants really in any category to be able to upgrade those spaces at higher rents. And then particularly on the anchor side, where we do have a lot of demand. We also have a very low rent basis in terms of what's expiring over the next few years. We've got rents on those spaces expiring at close to $9, and we're signing them at $16. So it really depends on the situation, but where we do see weaker tenants in any category, we're going to use the opportunity to upgrade. Greg McGinniss And so for specific boxes, how do you go about evaluating kind of their productivity, do you get sales information from them or Placer data? How are you going about kind of deciding if their higher risk location or not that you might need to be backfilling or proactively filling? Brian Finnegan We get both. I mean, we get sales for the majority of the portfolio, and we do get traffic for all our tenants. That's certainly helped us be a lot smarter. The other thing is we've got great relationships across our platform, particularly on the national account side, where - even where we don't get reported sales, we'll often get a number of those volumes in the conversations with our tenant, and that's because of the trust our team's built. So we do utilize the tools that you're talking about, whether that's Placer or whether that's other tools related to traffic, but we also get sales from the bulk of our tenants. We're also adding sales reporting when we have renewals coming up and some in leases where we're not getting that today. And then again, the relationships that we have with these retailers really shows the trust where we're able to get some of those sales volumes as well. We're in a great supply-demand environment that allows us to drive the optimal outcome for space as it comes due. And you see it in the spreads. You see it in the renewal spreads as well as the new leasing spread. So we're not only taking this opportunity to upgrade the portfolio and continue to upgrade tenant quality, we're also using it to drive true organic growth, and it's in the numbers. Greg McGinniss Okay. Thanks. And just one final point on that is, Brian, how many of the stores or what percentage of the big box stores are you getting individual store sales on? Brian Finnegan We get sales from about 70% of the portfolio today. We get it for almost all of our grocers and that's 70% across all size ranges. So I don't have the particular anchor number today. But again, that percentage of tenants that are reporting sales has improved as we've been able to add sales reporting as renewals come up. So we've been very intentional about that, and I expect that to continue to grow. Jim Taylor And as Brian alluded to, our national accounts team is held accountable to understand productivity where sales reporting isn't required. So when you supplement that with the Placer AI data in terms of traffic, which is a great proxy for sales productivity, you have a pretty good view, which not only helps you understand the health of the underlying tenant but also how you best drive the economics upon renewal. Thank you. Our next questions come from the line of Alexander Goldfarb with Piper Sandler. Please proceed with your question. Alexander Goldfarb Hey, good morning and [indiscernible] on the promotions all around. Just two questions, I guess, one question and one follow-up. On the - going back to the tenants, clearly, McDonald's out with their news on consumer pushback. It's been sort of a common theme for other, especially in the food area. Just an update on what you're seeing across your retail portfolio. Are you - are retailers really talking and concerned about changes in consumer shopping and purchase patterns or is this just people reallocating a little bit within each of these different categories. And overall, it's really not affecting the business in any way that affects their leasing. Jim Taylor The leasing decision is a long-term decision and not certainly driven by quarterly performance. As the retailers are looking at their pipelines out to 2025, 2026 and beyond and they're committed to the stores. As we look at our real-time traffic data, we're actually very pleased with how traffic at our centers and our major tenants within those centers continues to improve as we execute our strategy. And in terms of are we hearing it from tenants, really quite to the contrary. The tenants still are in a posture where they're trying to get their store opening plans filled and they're being very aggressive to do that. Alexander Goldfarb Okay. And then just a follow-up is, looking at your leasing the signed but not yet commenced, the wider gap is with the small shop, the under 10,000 square feet. And presumably, that's the more lucrative economics for you guys. Steve, can you just give a sort of how we should think about the impact to earnings from a 100 basis point increase in occupancy from small shop versus a 100 basis point increase in over 10,000 square feet. Just trying to get a sense of the impact to FFO because have to believe that it's much more advantageous to the boost from the smaller shops and the bigger shop as your occupancy increases. Brian Finnegan Yes. I mean I don't know that I can quantify the exact input, but I think your general thesis is correct, right? The smaller shop tenants are going to pay a higher rent and have a higher contribution to recoveries than you would on the anchor side. Jim Taylor And that follows through when you look at the average rents we're achieving both on the anchors and the small shop, your point is correct that there's a greater multiplier that's part of that $65 million of signed but not commenced rent. [Operator Instructions] Our next questions come from the line of Caitlin Burrows with Goldman Sachs. Please proceed with your questions. Caitlin Burrows Hi. Good morning everyone. Maybe just another pickup on the impact of occupancy improvements. You had a good pickup in build occupancy in the quarter and talked about how the snow pipeline is still quite large. What's your near to medium-term expectations for build occupancy, can the sort of pace of openings and rent commencements continue or maybe even accelerate from what we saw in the quarter? Brian Finnegan Caitlin, this is Brian. You normally would expect build occupancy to continue to trend higher in the back half of the year as we have kind of the bulk of those openings happening in the late third, fourth quarter, particularly with anchors. Now depending on if we get a few store closures back, you may see a dip in that. But that would be the normal course billed occupancy trajectory as we head into the end of the year. And again, we just talked about the spread between leased and build, particularly on the small shops. We'd start to have a number of those shops coming online at year-end and even in the balance as we get into next year. And the pipeline continues to be very strong. We're very encouraged just with the depth of demand and the size of the illegal pipeline despite the fact that we're raising occupancy to these levels. So - but overall, the trajectory you should expect to see that to rise as we go through the balance of the year. Caitlin Burrows Got it. Okay. And then just another one on pricing. So I mean, your new lease spreads have been very strong for a very long time, and this quarter was record level, the renewal pricing is also really strong. I guess on the option side, is there anything you can do to limit kind of the drag from the impact of options? And is that anything you can do near term? Or is it more related to leases you signed today and the eventual options they may or may not have in the future? Jim Taylor Since we began, our focus has been on giving fewer options, and we've been very successful, Brian and team as we've been executing the plan to do that. And so not only not giving options but giving fewer options and situations where they're otherwise required. And that's really how you impact that. It's something that occurs over time as you execute fewer and fewer options across the portfolio. Brian Finnegan And Calin, I would just add, too, that we're making incremental progress. You only have to give an option, right? In this environment, where maybe those option increases in the past with anchor tenants were 10%, and our team is pushing them to 12.5% or 15%. To Jim's point, maybe you're eliminating anchor number of anchor options from, say, four to two. The other thing that we've done is we've introduced the fair market value concept that was pretty much a California phenomenon into other parts of the country where we've had to give those primarily with national tenants. We're giving almost no options with local tenants. And to Jim's point, it's something our team is very focused on. If you were to sit in a committee on a Friday and here our head of leasing, David Gersenhaver. He's asking that question. as deals come into committees, do you have to give that option. Can you reduce those options. So it's something we're going to continue to remain focused on, but something we've been doing for a while. Thank you. Our next questions come from the line of Juan Sanabria with BMO Capital Markets. Please proceed with your questions. Juan Sanabria Hi. Thanks for the time. Just a question with regards to the same-store NOI guidance. Obviously, there's a slowdown implied in the second half. Can you just give us some color or details around what's driving the slower assumed second half? And what are the key variables within the guidance range? Brian Finnegan Yes, I think the first thing you got to think about when you think about the same-property NOI is just the gross and base rent, right? Because ultimately, the growth in same-property NOI is going to be largely dependent on that growth. And - for the first half of the year, it was 380 basis point contribution to the same-property NOI. And you'll see implied in our base rent guidance of $425 million to $475 million basis point contribution, you really see that starting to ramp up sort of what Brian was talking about within the signed not commenced pool. Obviously, in the first half of the year, bad debt as a percentage of total revenues was 20 basis points. We talked on our last quarter call that did benefit from just the timing of real estate tax collections and we expect that to be a headwind to the back half of the year as we get back to that, what we're expecting to be a total run rate of 50 to 75 basis points. So I think that deceleration in the bad debt is sort of offsetting a lot of the acceleration that you're seeing in the base rent line. Juan Sanabria Okay. Great. Thanks. And then just on the acquisitions pipeline. I think you mentioned $200 million in the prepared comments. Just curious on the types of assets or the larger assets or smaller kind of more traditional neighborhood grocery-anchored centers. Just curious on where you're seeing the opportunity set with regards to kind of what's in the pipeline today? Mark Horgan Yes. That pipeline is larger - the assets are larger than what we bought in the first half of the year, in part because of what we bought in the first half of the year was smaller. So it's really truly assets that look a lot like the meat of our portfolio. And importantly, there are assets where we see the ability to drive strong growth they sit within our footprint, and we have been targeting a bunch of those for acquisitions for quite some time. So we're excited about the opportunity we're seeing in the existing pipeline. And frankly, beyond the existing pipeline as we continue to try to dig out deals across the country. Juan Sanabria And maybe just one more if I can be a little greedy here. You talked about foot traffic being solid and having increased amount of data points on retailer sales. But given the comments that Alex made about the more cautious comments by both luxury and low-end retailers, are you seeing any slowdown in retail sales from your retailer base across the portfolio? Thank you. Our next questions come from the line of Floris Van Dijkum with Compass Point. Please proceed with your question. Floris Van Dijkum Good morning, guys and congrats on the new titles. So following up on that acquisition pipeline. Maybe if you can talk a little bit about what you're seeing in terms of pricing? And maybe switch the question a little bit more. Are you targeting value-add acquisitions? Or is it mostly complementary or infill acquisitions, just like what you've done in Hilton Head next to existing centers. Jim Taylor I'll let Mark handle the broader pipeline for us. But we really are looking at kind of core plus value-added type opportunities where we can bring our better platform to bear to drive better outcomes in rent and NOI growth, additional asset densification, et cetera. So you're not seeing us playing on the core side, but we're - the encouraging thing is that we're finding really attractive opportunities within our core markets to further cluster infill type investments, where we understand where the market rents are, we understand what the tenant demand is to be in that particular center and we believe we can generate above-average growth. Mark Horgan Yes. I think it's well said, Jim. And when we look at acquisitions, we're also thinking about those dispositions, I think it's important. I said it earlier, when we're selling assets - we're selling assets where we really maximize value and maximize that IRR going forward. And when we're looking at that pipeline, we're just seeing much better higher IRR mine versus what we're selling, which we hope will contribute to the long-term growth here. Floris Van Dijkum Great. And presumably, those the acquisitions and dispositions are they going to be similar type cap rates? Mark Horgan Yes, it's interesting. When we look at our - what we've done year-to-date, as we talked about last quarter, our blended cap rate for what we sold year-to-date is into the 4s we're buying today into the high 6s. I think that will even out over time. Floris Van Dijkum Great. And then maybe my follow-up question on, I noticed, obviously, great new leasing spreads, but you're spending a lot of money to achieve some of those spreads. I think I calculated $205 a square foot in lease costs this past quarter. Maybe talk - I suspect it has to do with some of the cons boxes or some of the other boxes that you're transitioning to Sprouts or other grocers but if you could talk a little bit about how long will those elevated leasing costs persist in your view? Or do you think that that's going to slow down at some point and have or go even lower? Brian Finnegan Floris, this is Brian. I'm not tying to the $206 a foot. But I would just point to the fact that net effective rents were a record for the portfolio this quarter. We show you the net effect of rents, so you can ultimately see the impact of cost there. They're coming off a record from last year. What you're seeing in terms of the leasing CapEx, it was somewhat elevated last year versus historicals, and it will be remained at that level this year in terms of the TIs. That's just because of the fact that our team has leased so much of the space that we took back last year and leased it very quickly. I'd say on average, the box backfills that we've done. We've talked about in the past we averaged around $50 a foot for the Bed Bath spaces. That's consistent with what you're seeing, where we are spending a bit more like the Sprouts example that you gave, we're getting it back - we're getting it back in rent, certainly. I'd say just for CapEx overall, though, we have been very prudent in terms of where we've been spending. You see our maintenance CapEx, now it was down last year versus 2022. It's trending down again and will be down by year-end, really reflective of the changes that we've made and the improvements that we've made across the portfolio and that leveling off. Our reinvestment spend, we've talked about that being $150 million to $200 million a year. We're going to be at the high end of that range this year as we bring on some of these really strong projects like those that Jim and I have both highlighted. But to your point, as occupancy increases, and there continues to be demand. Our team is leveraging that demand to have tenants take more existing conditions, tenants are getting much more flexible in terms of the age of the roof, the age of the HVAC. So you'd expect that to moderate. But I think - on the whole, why you're seeing some of the leasing costs somewhat elevated is just because our team has addressed so much of that space so quickly. Thank you. [Operator Instructions] Our next questions come from the line of Haendel St. Juste with Mizuho. Please proceed with your question. Haendel St. Juste Thank you for taking my question. I wanted to go back to Big Lots for a moment. You have more exposure there than cons, I think it's 27 boxes, 70 bps of APR. I'm curious what you've heard on how many of those stores they might be looking to close in your portfolio. And we're hearing that they may be looking at subleasing some of their own space directly to third parties. So I'm curious if you're seeing any of that and if you expect that to perhaps limit your opportunity to get back some of those boxes and benefits in the re-leasing yourself. Thanks. Brian Finnegan Haendel, this is Brian. So just as it relates to Big Lots, we reduced our exposure again by 30% since prior to the pandemic. We signed leases with the likes of Aldi and Sprouts and Ross here recently - recently recaptured big lot spaces. We did have four stores that were on the initial closure list. Two of those are already leased, one with a great fitness use and one with a great off-price operator. So as we look - and we don't have any additional color in terms of the number of stores that we will get back or the timing as it relates to anything announcing additional store closures. What I could say though is we have Big Lots boxes in markets like Philadelphia and Dallas, and we're - we'd be taking some of the space back in the tightest box supply environment than we've ever seen. So we feel really good about the demand we're seeing for that space. We were very opportunistic early in the Bed Bath discussions, too, about taking space proactively and we'll look at that as well because we want to ensure that we control our own destiny, but we'll be prudent with those decisions as we assess them center by center. Haendel St. Juste And are you hearing anything on the re-leasing of the boxes themselves to third parties? Brian Finnegan Yes. I think, look, they probably see the same value that we do - and again, we're going to - we showed up at the auction. We were for Bed Bath. We were able to get control of one of our boxes that we've already leased in New England. So we'll assess that as they come along. And I would say, look, our team has already been very proactive. Again, there were four stores on a closure list that just came out, two of them are already leased. So we've been getting ahead of a number of these names, particularly when we hear of potential store closures or potential weakness and feel really confident in our ability to capitalize on them and we'll be opportunistic as it relates to proactively recapturing that space. Haendel St. Juste Got it. Thank you. And then just a follow-up, you mentioned Bed Bath. The new anchor lease spreads were very high in the quarter. I'm curious if any of that included any of the Bed Bath backfills. And remind us again of the timing of the cash flow impact that you expect from the Bed Bath. Brian Finnegan Well, just starting on the cash flow. That's already started to come online. We do expect the bulk of that to come online next year. We're effectively finished with those boxes. Interestingly, it didn't really include the Bed Bath because we had already leased all those boxes in the quarters prior to this. And I think what this shows you is the low rent basis that we have and the opportunity that we have across the portfolio, not just with one tenant or one part of the country, it was fairly broad-based where we saw that this quarter. But ultimately, we're thrilled with how quickly our team is really addressing any space that we've been getting back in this environment and expect us to continue to do that. Haendel St. Juste All right. Thank you and congrats on the promotion. Thank you. Our next questions come from the line of Jeff Spector with Bank of America. Please proceed with your questions. Andrew Reale Hi, this is Andrew Reale on for Jeff. Thanks for taking our questions. West Center is about 99% leased. What's the lease rate at Fresh Market Shoppes? And can you just talk more about the opportunity set at the two assets, if there are any larger expirations in the near-term and what mark-to-market opportunities look like? Mark Horgan Sure. So at West Center that if you looked at that on the site plan, it's really an adjacency to the center wheel behind they called three villages. And that's really unlocking the opportunity to figure out what the overall plan is for three villages when you include that outparcel. So that vacant box you mentioned is the one at West, I'm sorry, Village Center behind West Center, which is early but really exciting steps here in the first couple of months of ownership. With respect to Hilton Head, it's 100% occupied and what we see there is an asset that's been under managed and under-rented, and we're very excited about the opportunity to drive low risk, high growth there. Andrew Reale Okay. Thanks. You also spoke to adding a few more repositioning and redevelopment projects to the pipeline this quarter. Just curious if it's becoming any easier to find these types of opportunities. Any color on your opportunity set to retouch assets and how that's trending would be helpful. Thanks. Jim Taylor Yes. It's really the advantage our platform brings. As a team, we look at acquisition opportunities and we really are viewing them through the lens of a value-added investor where we have the opportunity to raise rents but also reposition, densify and add necessary uses to the acquisitions. So - the nice part about our strategy is that we've successfully harvested a significant amount of opportunity in our existing portfolio. Importantly, a significant amount of opportunity remains several hundred million that we expect to execute over the next couple of years. And then we continually add that as we've demonstrated in South Florida, as I think we'll demonstrate in some of these more recent acquisitions the opportunity to add value through incremental reinvestment. Thank you. Our next questions come from the line of Samir Khanal with Evercore ISI. Please proceed with your questions. Samir Khanal Hey, Brian. Good morning. I guess, I mean you talked about the Conn's boxes, the Big Lots boxes. I mean this as we think about the setup into next year. What does that tenant exposure sort of that watch list look like, I guess, for the next six to 12 months? Thanks. Brian Finnegan I'd just start by saying that the credit base of this portfolio is as strong as it's ever been. We put in a rigorous underwriting process coming out of the pandemic with our financial asset management team. And that has really paid off. And you can see you pay it off in record low move-outs for the portfolio. You can see it paying off in terms of the renewal growth that we've been able to drive because we've got better tenants in there that are driving more traffic. Again, as it relates to those two specific situations, we have a very low exposure with Conn's at 30 basis points. We've already leased one of the boxes. The other boxes are in places like Raleigh, Houston and Atlanta which are great markets. And ultimately, as it relates to Big Lots, we have consistently been lowering our exposure there and backfilling them with better tenants at higher rents. So I think it's encouraging that we've already got leases on some of the stores that they've announced. And as we think about it ultimately into next year, we are looking to see how we can use this as an opportunity to continue to position ourselves to upgrade these spaces. Samir Khanal Okay. Got it. And I guess, Jim, just shifting over to you. You clearly have occupancy that continues to go up, spreads are strong. It looks like acquisitions maybe even picking up your leases we saw in the quarter. I mean, I guess what's the biggest risk to the portfolio or the sector at this time you think? Thanks. Jim Taylor I think we're really well positioned even for a slowdown given where our rent basis is. And it's a point I've made many times that in a strong environment such as the one that we're in, we're positioned to outperform largely because of that rent basis. Should you see a slowdown in retailer demand, which we're not seeing any signs of, again, retailers are doing business out to 2025 and 2026 but where we do, we think we're particularly well positioned given the transformation of the portfolio given our rent basis and given our overall execution. So I don't see any major risks as we look out ahead beyond general economic trends and cycles. But even given that, I believe we're really well positioned. I'm also very proud of how we've handled our balance sheet, how we continue to drive improvements in overall debt to EBITDA, how we continue to capitalize in this environment on demand for our fixed income paper to continue to term out our balance sheet and put us in a position where we have $1.7 billion of liquidity and no need for external capital to fund our business plan for the next several years. So when you think about, again, rent basis, conservative capital structure, upside, the reposition of the portfolio, I think it's an all-weather plan. I think it's one that positions us particularly well whatever the economic climate is. Thank you. Our next questions come from the line of Linda Tsai with Jefferies. Please proceed with your questions. Jim Taylor Hi, Linda. Can you check if yourself muted, please? Operator, we can put her back in the queue. Yes. Sorry about that. Just with the closures taking a touch higher in the second half, reverting you to the historical bad debt run rate from where you sit today, could bad debt range 75 to 110 bps for 2025? Jim Taylor I think one - it certainly could. I think what we've been pleased by is the overall improvement in credit quality within the portfolio and how that's coming through in terms of the bad debt performance. We do expect a greater amount of revenue deemed uncollectible in the second half of the year, as Steve alluded to. And I don't want to give guidance yet on 2025. But I would frame it against the overall improvement in the portfolio. Linda Tsai And then would you expect just given the strength in your overall portfolio, what's kind of like the longer-term same-store run rate in your portfolio over the next few years? Jim Taylor I think we're well positioned to achieve that same-store growth in the four plus percent range over the next several years. Thank you. Our next questions come from the line of Mike Mueller with JPMorgan. Please proceed with your questions. Mike Mueller Thanks. Hi. Just a quick one here. We know the redevelopment pipeline is sizable, but are you evaluating any new ground-up development opportunities as well? Jim Taylor We've been approached by developers. We've been approached by certain tenants regarding ground-up development opportunities. And to date, they haven't penciled. You've got a higher risk, lower return, and it just doesn't compare favorably to the opportunities we have to reinvest in our existing assets. So I do think it's going to take a while to see new ground-up development of any meaningful amount, not only because of the higher risk and lower returns, but also because it's just a difficult environment in which to finance that type of activity. So we've seen some, but I don't expect a material increase in the next couple of years. Thank you. Our next questions come from the line of Ki Bin Kim with Truist Securities. Please proceed with your questions. Ki Bin Kim Thanks. Good morning. Just a couple of follow-ups. You added a couple of new projects to your redevelopment pipeline. Can you just remind us how you define the yields, the 9% yields that you're getting and if that includes landlord work? And second, if you look at the trend on rents and construction costs, does the next batch of potential redevelopment projects. Is that yield potential - has that increased over the past year? Or as it or relatively stable? Jim Taylor Yes. That return is the incremental rent over the project level costs and the total project level cost. As we look out in the pipeline, because of the strong demand environment we're seeing - we're actually seeing positive upward pressure in some of those returns. As you saw in terms of the overall portfolio of reinvestment growing from an average of 8% to 9%. So we're encouraged by what we're seeing looking forward. Thank you. Our next questions come from the line of Omotayo Okusanya with Deutsche Bank. Please proceed with your questions. Omotayo Okusanya Hi, yes, good morning. Let me add my congratulations to the whole team. A quick question on Kroger, Albertsons and kind of the latest developments with again, the court case getting accelerated to September. Just curious what you guys are hearing, whether it kind of changes how you guys are thinking about your exposure to those two grocers. Brian Finnegan Omotayo, this is Brian. We don't have much more to report outside of what's been in the news. We were encouraged by the fact that none of our stores were on the initial divestiture list. We feel good about our fleets in really either scenario. We've got great stores that have been reinvested in for both Kroger and Albertsons, the markets where we do have some overlap are in a very tight supply environment, some of the tightest supply that we have in markets like Dallas and Southern California and Denver. So we have said and continue to believe that a merger would be good for both companies and have been watching this very closely, but feel really good about our fleet. I mean these stores produce higher sales volumes than the over $700 a foot that we're getting from grocers across the portfolio. So - and we're really encouraged by the fact that they have been invested in here over the last few years. Thank you. We have reached the end of our question-and-answer session. I'd like to turn the floor back over to Stacy Slater for closing remarks. Stacy Slater Thanks, everyone, for joining us today. Enjoy the rest of your summers. Thank you. This does conclude today's teleconference. We appreciate your participation. You may disconnect your lines at this time. Enjoy the rest of your day.

Armstrong World Industries, Inc. (AWI) Q2 2024 Earnings Call Transcript

Good morning, ladies and gentlemen. Thank you for standing by. My name is Abby, and I will be your conference operator today. At this time, I would like to welcome everyone to the Armstrong World Industries Second Quarter 2024 Earnings Conference Call. [Operator Instructions] Thank you. And I would now like to turn the conference over to Theresa Womble, Vice President of Investor Relations and Corporate Communications. You may begin. Theresa Womble Thank you, Abby, and welcome, everyone, to our call this morning. Today, we have Vic Grizzle, our CEO; and Chris Calzaretta, our CFO, to discuss Armstrong World Industries second quarter 2024 results and rest of year outlook. We have provided a presentation to accompany this call, and it's available on our Investor Relations section of the Armstrong World Industries website. Our discussion of operating and financial performance will include non-GAAP financial measures within the meaning of SEC Regulation G. A reconciliation of these measures with the most directly comparable GAAP measure is included in the earnings press release and in the appendix of the presentation issued this morning; both are available on the Investor Relations website. During this call, we will be making forward-looking statements that represent the view we have of our financial and operational performance as of today's date, July 30, 2024. These statements involve risks and uncertainties that may differ materially from those expected or implied. We provide a detailed discussion of the risks and uncertainties in our SEC filings, including the 10-Q we filed this morning. We undertake no obligation to update any forward-looking statements beyond what is required by applicable securities law. Thank you, Theresa, and good morning, everyone, and thank you for joining our call today. Today, we reported another quarter of strong and record-setting results and an increase in our guidance for the full year 2024. It was a quarter of strong execution on all fronts as we continue to drive consistent growth from our initiatives and operate very efficiently. So let me begin by thanking our nearly 3,500 employees now including our team members of 3form for their continued efforts and commitment to the execution of our strategy through the production of the highest quality products and the best-in-class service levels that differentiate Armstrong in the marketplace every day. Together with their commitment to excellence and winning the right way with integrity and respect, Armstrong will continue to be successful for many years to come. Turning to our financial results this quarter, we generated total company revenue growth of 12% and adjusted EBITDA growth of 13%, with total company margin expansion. This marks five quarters in a row that we have achieved year-over-year adjusted EBITDA margin expansion for the company. Adjusted net earnings per share increased 17%, marking the sixth consecutive quarter of year-over-year adjusted EPS growth, all against a muted market backdrop. Our Mineral Fiber segment delivered net sales growth of 7% year-over-year with strong average unit value or AUV, along with increased sales volumes driven by stabilizing market demand, which I will talk more about shortly and contributions from our growth initiatives. These initiatives include our automated design platform ProjectWorks and Canopy, our online platform and new product innovation efforts. Both innovative digital platforms are advancing in their capabilities and are making an increasing impact on our business. In the quarter, Canopy sales increased over 20% from prior year results and had its largest shipment month ever in June. Canopy also positively contributed to EBITDA in the second quarter. With ProjectWorks, we continue to integrate more of our products into our digital catalog, expanding our coverage and increasing the number of projects where we can improve the design to construction process. More and more architects and contractors are using ProjectWorks. And for the first half of the year, the quoted value of projects moving through this platform has increased a remarkable 52% from the first half of 2023. Further ProjectWorks is strengthening our engagement with architects and contractors positioning us to win more specifications and sell more product into more spaces. The growth of both of these digital initiatives is further differentiating Armstrong in our industry. With these contributions from our growth initiatives and contributions from continued AUV growth, moderating input costs and earnings from our WAVE joint venture, Mineral Fiber EBITDA increased 10% and our EBITDA margin percent improved by 130 basis points, reaching nearly 42% in the quarter. Our plants also continue to operate at a high level, operating efficiently and delivering high-quality products. Again, these results reflect another quarter of strong performance and execution. Now turning to our Architectural Specialties segment. Net sales increased 26% year-over-year, largely due to the inclusion of our 3form acquisition in April as well as contribution from our 2023 acquisition of BOK Modern. In addition to the inorganic contribution, we saw growth in custom project sales across several product categories. Now as previously reported, we've been awarded large airport projects, including Pittsburgh and Seattle, International Airports. And now more recently, we have been awarded projects at the Tampa and Fort Myers airports as well as other smaller regional airports across the country. We continue to expect federally funded transportation projects to be a multiyear opportunity for our AS segment. Our quarter-to-quarter sales in this segment are likely to continue to be choppy and uneven due to the project timeline variability due to a variety of dynamics. These include labor availability, inflation and speed of project funding. That said, quoting activity remains healthy and our backlog remains strong for the overall segment. Adjusted EBITDA for the AS segment, with the inclusion of 3form increased 25% with a margin of 18.4%. Importantly, adjusted EBITDA margin for the organic AS results continue to improve. We look forward to continuing the integration of 3form onto the Armstrong platform and expect to see margin improvements as we do this. Although it is still early days in the 3form integration, we are pleased with their performance in the second quarter and how the integration is progressing. We continue to be excited by the unique capabilities of 3form using color, texture and light to elevate the design of a space. Our other recent acquisition BOK Modern also has performed in line with our expectations, and we believe their ability to design and develop integrated architectural metal systems for interior and exterior applications positions us well for further growth in this category. Now before I turn the call over to Chris for additional financial details, I'd like to comment on the underlying market conditions we are experiencing. Broadly speaking, market conditions seem to have stabilized and have a sideways moving field to them. With this and feedback from our customers, we have modestly improved the outlook for the second half of the year, although a level of uncertainty remains around interest rates, inflation and the overall impact on the economy. While the office sector continues to be challenged, it is stabilizing with pockets of improved regional activity. We're seeing the early signs of renewed activity in some of the depressed markets like San Francisco, with the rise in AI demand for office space. We've also seen tech projects that had been paused throughout the Pacific Northwest start up again. And we're seeing a rebound in project bidding in the Mid-Atlantic in the New York Metros. These activities are in the early stages, but are encouraging signs. Other verticals like health care and education are holding steady, Transportation continues to be strong and data centers remain an area of rapid growth and provide higher value grid and component sale opportunities. We are currently tracking over 100 data center projects across the country. We're also seeing steady growth in new construction bidding activity and the latest Dodge forecast for new construction starts in 2024 remains in positive territory. These are good signals for 2025 and into 2026. And as we've demonstrated over the past several years, the benefit of our balanced set of end markets is one of the key stabilizing attributes of our business enables us to deliver consistent, profitable growth. Now I'll pause and turn it over to Chris for some more details on our financials. Chris? Chris Calzaretta Thanks, Vic, and good morning to everyone on the call. As a reminder, throughout my remarks, I'll be referring to the slides available on our website, and Slide 3, which details are basis of presentation. Beginning on Slide 6, we discuss our second quarter Mineral Fiber segment results. Mineral Fiber sales were up 7% in the quarter, primarily driven by favorable AUV of 6% and 1% from higher volumes. Favorable like-for-like pricing and, to a lesser extent, positive mix, drove the strong AUV result versus prior year. Higher volumes were driven by stabilizing demand as well as contributions from our growth initiatives. Mineral Fiber segment adjusted EBITDA grew by 10%, expanding adjusted EBITDA margin by 130 basis points to 41.7%. Adjusted EBITDA margin expansion was driven by the fall-through of AUV and lower input costs. These benefits more than offset an increase in SG&A. Manufacturing productivity in the quarter more than covered inflation and a temporary uptick in plant-related costs. Lower input costs were driven primarily by freight and energy deflation as well as a benefit from inventory valuation. And the increase in SG&A was driven primarily by higher incentive compensation and higher employee costs due to inflation. The strong second quarter adjusted EBITDA margin result for Mineral Fiber marks the sixth consecutive quarter of year-over-year adjusted EBITDA margin expansion for this segment and demonstrates our focused efforts to drive consistent margin expansion despite uncertain market conditions. On Slide 7, we discuss our Architectural Specialties or AS segment results. Sales growth of 26% in the quarter was driven primarily by contributions from our recent acquisitions of 3form and BOK Modern as well as organic sales growth driven by some of the larger transportation projects that we have previously mentioned. We're happy to report that the 3form business performed as expected in the quarter and the integration work is on track. Including the acquisitions of 3form and BOK, second quarter total AS adjusted EBITDA margin was 18.4% and compressed by 10 basis points. AS organic sales patterns continue to be impacted by project dynamics and can be lumpy quarter-to-quarter. Despite lower-than-expected organic sales growth, we were pleased to see adjusted EBITDA margin expansion organically. We also expect to see the AS organic portion of the business continue to expand margins over the second half of the year. We remain on track to deliver the approximately 18% adjusted EBITDA margin target we had outlooked for the total AS segment in April. Slide 8 highlights our second quarter consolidated company metrics. We delivered 12% sales growth and 13% adjusted EBITDA growth with 10 basis points of adjusted EBITDA margin expansion, along with 17% growth in adjusted diluted net earnings per share. The drivers of the second quarter adjusted EBITDA growth are largely similar to the first six months of the year. And as we turn to Page 9, we present our first half consolidated company metrics, which reflect continued margin expansion. Notably, through the first six months of the year, with sales up 9% and adjusted EBITDA up 14%, margins expanded 160 basis points versus the prior year period. Adjusted diluted net earnings per share increased 20% due primarily to higher net earnings. Adjusted free cash flow increased 2%, and I'll comment further on that in a moment. Adjusted EBITDA growth for the year-to-date period was driven primarily by AUV fall-through and higher volumes, partially offset by an increase in SG&A costs. The recent acquisitions drove a majority of this volume benefit as well as a sizable portion of the increase in SG&A. WAVE equity earnings were also a strong driver of growth in the first half, helping to expand Mineral Fiber and total company adjusted EBITDA margins. Slide 10 shows our year-to-date adjusted free cash flow performance versus the prior year. The 2% increase was driven primarily by higher cash earnings and lower capital expenditures. Higher cash earnings were more than offset by unfavorable working capital changes, most notably timing-related changes in accounts receivable and an increase in cash paid for income taxes largely due to higher earnings. This is captured with an adjusted operating cash flow on the bridge. The single-digit adjusted free cash flow growth result is lower than we expected through the first half of 2024, and it is timing related. Accordingly, we expect this working capital impact to reverse in the second half of the year, resulting in double-digit adjusted free cash flow growth for the full year. Our proven ability to consistently deliver strong adjusted free cash flow growth allows us to invest in all of our capital allocation priorities. As we discussed on our April call, in the second quarter, we acquired 3form for a purchase price of $94 million net of cash acquired. Along with this sizable acquisition, we continue to make capital investments back into the business and return value directly to shareholders through our regular quarterly dividend and share repurchases. In the second quarter, we paid $13 million of dividends and repurchased $10 million of shares. As of June 30, 2024, we have $692 million remaining under the existing share repurchase authorization. With a healthy balance sheet and ample available liquidity, our intent to complete additional acquisitions remains unchanged, and we remain committed to advancing all of our capital allocation priorities. Slide 11 shows our updated full year 2024 guidance. We are raising our guidance on all our key metrics to reflect our solid second quarter performance and improved expectations for the second half of the year. While macro uncertainty continues, we believe market conditions have stabilized. Accordingly, we have removed the downside scenario from our outlook. We now expect full year Mineral Fiber volume to be down about 1% on these better-than-expected market conditions. We also expect full year Mineral Fiber AUV to be above the 5% historic average. We now expect total company net sales growth of 9% to 11% for the full year and expect total company adjusted EBITDA growth in the 10% to 13% range, up from our prior expectations of 8% to 13% growth. The change in our adjusted EBITDA guidance versus our prior guide provided in April is driven by improved mineral fiber profitability due to higher volumes, better AUV and lower input costs. There are no material changes to our AS segment guidance. For the full year, we expect adjusted free cash flow to grow at 10% to 14% and expect adjusted diluted net earnings per share to grow at 13% to 16%. Please note that additional assumptions are available in the appendix of this presentation. As we look to the back half of 2024, we remain committed to driving profitability and continuing to deploy cash to generate growth and create value for shareholders regardless of the market environment. And now I'll turn it back to Vic for further comments before we take your questions. As we have summarized, our business is performing well in this current environment. We're on track in 2024 to deliver annual revenue and earnings growth as we have in each year since 2020 in a muted commercial construction market, all while we continue to make investments for our future, investments to support the growth of our company through acquisitions like BOK Modern and 3form as well as through investments in our operations for productivity and in innovation to continue bringing new products to market aligned with next-generation market needs and aligned with longer-term secular trends for the built environment. In the last couple of quarters, we've discussed the rising demand for building solutions that can reduce the energy cost and the environmental impact generated by buildings. We are making great strides with product innovation focused specifically on energy savings and decarbonization. This includes our TEMPLOK energy-saving ceiling products, which are the industry's first ceiling tiles that can help regulate temperatures within buildings and reduce energy costs through a unique application of phase change material coupled with our mineral fiber tiles. This is the first ceiling product that pays for itself over time by generating energy savings of up to 15%. This economic return provides building owners and facility managers a reason to replace existing ceilings. We also recently launched an industry-leading line of Low Embodied Carbon products or LEC that helps tackle the challenge of embodied carbon in commercial buildings. The new Ultima LEC ceiling tiles are the lowest embodied carbon tiles on the market today, while maintaining its typical acoustical and aesthetically appealing attributes. Together, these products make a meaningful impact on the overall carbon footprint of a building and its operation. Although these products are in the early stages of their launch, the feedback from industry groups and the A&D community confirm these products are on trend for where things are going. And we expect the demand for these types of solutions to grow given the increased attention to decarbonization and the energy efficiency by industry standard setters, federal initiatives and increasingly state and local regulators. One example to note is the proposed lead version five standards from the U.S. Green Building Council that seeks to establish ambitious new standards for sustainable building practices with several guiding principles, including decarbonization, resilience and health. These standards call for additional reductions in operational and embodied carbon. Maintaining those standards will require finding additional sources of energy savings and decarbonization like the benefits provided by both our LEC and energy saving products. For perspective, there are close to 3 billion square feet of building space currently certified by the U.S. Green Building Council. Armstrong has a long history of supporting customers to achieve their lead project goals and working with the Green Building Council to drive real-world positive change through innovation. We're also pleased that our TEMPLOK product was named one of 17 new technologies that will be tested by a program run by the Department of Energy with the General Services Administration called the Green Proving Ground. This is a multiyear testing and validating program for innovative building technologies using the U.S. government's real estate footprint as testing sites. This program looks for new technology that can drive down operational costs in several buildings and help lead market transformation through the deployment of new technologies. Jetta Wong, GSA's senior adviser recently called the face-change ceiling tile made by Armstrong World Industries, a game changer because construction companies don't need special training to install the new tiles. We are thrilled to be part of this program and to be the only ceiling-based and phase change material solution included in the program. Again, we're in the early process of educating our customers on the benefits of these new products and building market demand. But interest is growing, and we have already taken orders with our largest order to date placed just last week. These products are important catalysts for the renovation activity that could lead to mineral fiber volume growth in the future. The innovation around new products is a key element, enabling AUV growth. And as many of you know, Mineral Fiber AUV is one of the core value drivers for our company and has been for over a decade. And with new products like low embodied carbon and TEMPLOK energy-saving ceilings, we are expecting AUV growth to continue. We are demonstrating, again, that ability in 2024. Investing in our AS segment is also a core value driver as we seek to grow revenue through acquisitions and market penetration while increasing the profitability of the businesses we bring on to the platform. In 2016, when we separated from our flooring business, this was just a $100 million business for Armstrong. In 2024, we are on track for this segment to well exceed $400 million in revenue. We are demonstrating success in penetrating the specialties category and doing so profitably. Our investments in digital growth initiatives, Canopy and ProjectWorks also support the overall business and are contributing to both sales volume and AUV growth. I'd also like to highlight our best-in-class service model and specifically within that, the critical role our distribution partners play in providing that last mile of service. Their partnership and excellent service supports growth for our metal fiber, our grid and architectural specialty products and it's essential for our success. We clearly have the best of the best distribution partners. All in all, our teams are executing well and 2024 is unfolding better than expected. We remain well positioned to continue delivering consistent profitable growth in these overall muted but stabilized market conditions. [Operator Instructions] And your first question comes from the line of Susan Maklari with Goldman Sachs. Your line is open. Hi. My first question is, you made some comments in your opening remarks about stabilized conditions and getting some feedback from your customers that is supporting this improved view that you have for the back half. Can you give us a bit more commentary on what you're hearing from them? And then you also mentioned that there's some depressed markets that are coming back, which is encouraging. Can you talk a bit about what you're seeing there, what those projects are? And how we should think about what that could mean for mix shift as well as perhaps some of these newer offerings start to gain even more momentum with some of those markets coming back? Vic Grizzle Yes. Susan, the -- as you know, we talked to our customers and with their visibility into their backlogs as a key input to how we think about the market conditions and so forth. And specifically, I think your question relates specifically more to office because that is probably the one that has been the biggest drag overall with healthcare and education, kind of hanging in there, transportation being strong. So let me address the office segment in particular, because I was referencing some of those new projects in the Pacific Northwest in particular, that were on hold. These were large office buildings for the tech companies that were put on hold that have come now back online as part of the encouraging signout out West in particular and in San Francisco with the artificial intelligence demand for moving into some of that lower-cost office space in downtown San Francisco. But when if I flight helicopter back up and look at broadly speaking, there's some real signs out there that support the stabilization view and what we're experiencing, what it feels like in the marketplace. Leasing activity in the office space was up 15% in the quarter. That's the highest quarterly volume since the pandemic. And connected to that, when you look at the sublease vacancy rates, they declined in the last three quarters. So consecutively in the last three quarters, with Q2 actually having the steepest rate of decline. So that's a really encouraging sign when you think about the availability, especially some of this Tier 2 and Tier 3 space. There's also -- I thought it was a very interesting survey that many of you may have read about was the P&C survey of CFOs that 65% of the CFO survey expect their office square footage to increase in the next 12 months. And some of you may remember, just two years ago, a similar survey of CFOs had exactly the opposite. They were looking to reduce their footprint. So that's another positive sign, I think, for overall demand in the office space. Again, together with some of the green shoots we're talking about in our distressed markets like San Francisco and some of the Mid-Atlantic areas as well. So I would say there are several things that are supporting, I think, the stabilization feel that we have in the marketplace and the conversations we're seeing with our customers. No, I was just going to say -- I think the second part of your question was really on how this contributes to the mix shift? And certainly, when markets like San Francisco, New York, Chicago and some of the larger metros, we have some of the richest value products going into those markets. It's always going to be helpful for those markets. When they come back, it will always be helpful to our mix overall to what we sell in those markets. So positive -- that's a positive sign also for additional product mix going forward. Susan Maklari Yes. Okay. Thank you for all that color. That's helpful. And then turning to Architectural Specialties, you've seen those margins holding really nicely in this quarter. Any commentary on as we look out and we think about some of these initiatives and these conditions that are coming through, how we get to that 20% perhaps next year? And how you're thinking about the integration of the recent M&A within that target? Vic Grizzle Yes. I think the play we're running on the kind of the organic part of our business and improving the margins is it's been very clear around the operational excellence we have to drive getting the throughput and the productivity from those investments we've been making in those businesses, so we could grow them and grow them profitably. So it's continuing to get that operating leverage and then really good discipline inside the marketplace, how we service and win these projects. That's part of what we do, and we're bringing that. I think it's just running that same play. We saw a benefit from that again in the second quarter. We're expecting that to continue each quarter as we go is to get better and better at that and drive those margins organically to that 20% level. So I like where we are. I think we're on the right track there. Of course, the 3form acquisition, we're kind of starting at zero here. We have to run our play to scale this business on the Armstrong platform. I like the progress we're making there. We're already after the synergies that we saw in the business case coming into that acquisition. So I think we're just going to go up about doing our work, driving the synergies, both the cost side and the revenue side to improve the margins in that business going forward. It's a very similar play that we've been running. Susan, I think you're very familiar with that, we've been running for the last several years. We expect to continue to do that. Susan Maklari Yes. No, I am familiar with it, and it's coming together well. So thank you for that color and good luck with everything. And your next question comes from the line of Keith Hughes with Truist. Your line is open. Keith Hughes Thank you. In the quarter, could you just talk about -- you've done some of this, but I just wanted to get a list. In the quarter in Mineral Fiber, what markets were positive and which markets were negative? Vic Grizzle Well, Keith, the markets that we spoke to, the health care and education. Education got off to a good start. As you know, it's later in the second quarter. It's mostly a third quarter dynamic, but we continue to see strength in the health care, especially on the East Coast and the West Coast, frankly, with a lot of the work connected to universities, both east and west. So it's all strength in health care and education. Certainly, the transportation, the bidding activity around transportation was very strong. Data centers continues to be very strong. And the Retail is kind of hanging in there. So flattish overall. But I think that's probably the bulk of the verticals for us. Keith Hughes And the office is still in there. You said some positive things for the future of office. Vic Grizzle Yes. Sure. I left that off, but I talked a lot about that in the last one. So yes, I would say it's moving sideways, but it's still at a lower level. overall. That's a drag overall on the other verticals for sure. Keith Hughes Okay. And if you look at your backlog in office, some of the positives you talked about in this call, would it be next year before something like that could potentially turn in a positive direction? Vic Grizzle I think for the most part, we're -- again, it's stable. I'd say we're -- the stabilization that we're seeing now, if these green shoots continue to materialize with the lag on some of these projects, you got to believe most of this impact is in '25. But it does give us confidence that we don't have the softening that we were expecting in the back half, and that's the main driver behind raising the guidance for the back half. There's some benefit, but really, to your point, Keith, the bulk of the benefit is in '25 and in '26. Keith Hughes Okay. Architectural Specialty has remained positive organically. It tends to have more of a higher construction component to it. How has that been able to continue the growth despite and there's obviously some headwinds on construction? Vic Grizzle Yes. We're still living off of positive new construction activity that occurred in the late part of 2022. As you know, that's an 18- to 24-month lag. So we're still seeing the benefit of some of that. But don't overweigh that because the large renovation projects are also equally as important as new construction in the Architectural Specialty business, it's about a 50-50 split between the two. And we're seeing some good activity there, and of course, in those verticals that we talked about, transportation and health care and to a lesser degree in the education segment. And your next question comes from the line of Adam Baumgarten with Zelman & Associates. Your line is open. Adam Baumgarten Hi. Good morning, everyone. Just thinking about AUV, I know you mentioned above 5% AUV growth for the year. It did about 7%, it looks like in the first half. Should we expect a similar year-over-year increase in the back half of the year? I know there's a price increase out there that I'm assuming you guys expect realization on -- so just some more color on the cadence of AUV as we move through the year. Chris Calzaretta Yes. So Adam, it's Chris. Yes, the back half of the year, a little bit softer on AUV as compared to the first half of the year. Really expect to get positive mix but -- and also positive price, but a little bit to a lesser extent on price than the first half of the year. And again, thinking about kind of some of the dynamics we've been facing in terms of deflation. So a little bit of a deceleration there on AUV in the back half, but certainly strong price contribution and positive mix. Adam Baumgarten Okay. Got it. And then just switching to AS just on the airport projects. You mentioned I think it was four or so, and I'm sure there's others. Maybe if you could size given the existing wins you have the cumulative opportunity from a revenue perspective and maybe some help on timing of when that actually hits the P&L. Vic Grizzle We're shipping in the Pittsburgh Airport project now and Seattle soon. So we -- some of the larger projects, and again, these are outsized projects to our normal average project size. So -- but these projects, as I mentioned, some of the smaller regional projects, they can be kind of normal, smaller normal-sized renovation projects. And then on the other end of the continuum, right, you have the Pittsburgh and some of these very large new projects. We have some that are in between that as well. So it's a whole continuum of different sized projects. But they're hitting the P&L. Certainly, in the back half of this year, we'll see that and into '25 and into '26. As I said in my remarks, with the bidding activity and the number of airport projects that we're tracking across the country, this is at least a three, four year tailwind in terms of that particular sector on the Architectural Specialty business in particular. Chris Calzaretta Adam, maybe if I could just add a little more context around the phases -- different phases of those projects. A lot of them are multiphase within these transportation jobs. So that can lend to choppiness, lumpiness as those individual phases are completed and shifting. So we'll see sometimes some choppiness like we've talked here in the second quarter associated with those types of larger SCOT projects. And your next question comes from the line of Garik Shmois with Loop Capital. Your line is open. Garik Shmois Hi, thank you. I think in prior quarters, you've spoken to project delays. I think it was maybe particularly acute after Q1. I'm just wondering if it's fair to assume that the pace of delays has slowed. And if so, maybe what's bringing some of those projects back. Vic Grizzle I think we're still seeing -- we're still seeing delays. I think the reason we're seeing delays has actually changed a bit. It was more supply chain related in the last, I would say, 12 to 18 months. It's been more labor and funding, especially these large projects, some of the lumpiness of the funding can influence the rate and pace of these projects. So we're seeing a little bit of the difference -- the mix of drivers, but I wouldn't say it's better or worse in terms of overall delays. They're episodic depending on the projects and the type of projects. But yes, that's, to Chris' point, that's causing some -- could cause some of the quarter-to-quarter lumpiness. Garik Shmois Okay. Got it. That's helpful clarification. And then just on SG&A, the increase in the quarter. I was wondering if you could maybe just size directionally how much was inflation, how much was performing comp? How much was the acquisition impact? So maybe just how to think of the SG&A piece in the back half of the year? Chris Calzaretta Yes. So yes. So in the quarter, obviously, you saw incentive comp that's based on performance. And again, within SG&A, you have that inflation, call it the salaries and wage inflation, that's also included in the SG&A line. But largely, the contribution to SG&A here is related to the 3form acquisition. So kind of when I think about that contribution for the quarter, that was really the driver of the SG&A increase here in the second quarter. And on a more normalized run rate basis, that's something to continue to model in given the 3form SG&A loaded. Your next question comes from the line of Kathryn Thompson with Thompson Research Group. Your line is open. Brian Biros Hi, good morning. This is actually Brian Biros on for Kathryn. Thank you for taking my questions. On the improved outlook in the second half, maybe can you just break that out between new construction versus R&R.? It seems maybe the new side is seeing slightly more of the improved outlook based on your comments, if I'm interpreting that correctly. But if you could address how that breaks out between the two would be interesting to hear. Vic Grizzle Yes, really difficult to break them out. But I would say the pattern that we've seen in the first half is I think indicative of what we're expecting to see in the back half, we -- it's fair to say, Brian, that the new construction part of the market is still positive as we are, I think, benefiting from some of those starts, as I mentioned, in the last half of 2022, and they continue to be positive -- starts continue to be positive. I think we're really seeing the softness on the renovation side and in particular, the discretionary renovation side as I think people are still waiting for some of this uncertainty to clear up. So I wouldn't say there's a big departure here in our outlook in terms of new versus renovation activity in the back half versus the first half. Brian Biros Got it. And then with, again, better outlook, raised guidance, I assume that means you'll at least have slightly better throughput on the Mineral Fiber production lines. I guess, given the throughput business, the margins, is there any way to quantify or think about that productivity or margin benefits in the second half? Vic Grizzle Well, I think the way to think about that is we're on track to deliver our productivity goals. We were slightly ahead in the first half. And again, with this modestly improved outlook on the volume side, we should really have a good degree of confidence that we're going to be at or above our productivity targets for the year. So we feel good about that. And again, the profitability of the company and our ability to manage both the cost side as well as the AUV side should continue to follow through and deliver profitable growth. We're expecting to expand margins -- maybe to your point, Brian, we're expecting to expand margins both in Q3 and Q4 to continue that trend that we've been on. Chris Calzaretta And maybe one other thing to add is within Mineral Fiber, our adjusted EBITDA margin is increasing. If you look at our full year assumptions for 2024, it was greater than 40%. We're now at about 41% to Vic's point around overall margin expansion. Your next question comes from the line of Philip Ng in with Jefferies. Your line is open. Philip Ng Hi, guys. It is pretty encouraging that you're signaling that the market is stabilizing here. I think you teased this a little bit in the last question, that it sounds like new construction is still pretty good because you're lagging some of the strength you saw in back half 2022 are not full resilient. Is this how you could think about it. Any more color on how major rental has been, and it sounds like it's still weaker but is it at a point where it's less bad? Just give us a little more context on how these three buckets have performed? Vic Grizzle Yes. I would say it continues -- it's stable. It's part of the stabilization equation for me is that we're getting a sideways kind of feel in terms of the number of projects and the value of these projects on the renovation side. And it's a fine line between some of those major renovation work and some of the discretionary renovation activity. So I wouldn't put too fine a line in between the 2, but they both seem like they're stabilizing. Even though at this kind of lower level, they're kind of moving sideways and stabilized. And again, the positive, we're still benefiting from some of the positive new construction activity, as you mentioned. Philip Ng Okay. So that's helpful. So it sounds like you at least have some level of confidence, things are stabilizing in the back half. So when we kind of look at the 2025, a lot to unpack here, right? You kind of called out a handful of green shoots that could be a good guy for next year and then going to 2026, new construction starts for Dodge have obviously weakened, I think, the last 1.5 years or so. And rates are coming down, right? So help us kind of unpack all those different cross currents in terms of how we should think about 2025? Is that a year where things gotten in flat? Or kind of still move sideways? Is there some risk that you could get a double dip, -- like how should we kind of contextualize your recovery into 2025? Vic Grizzle Yes. I think the fact that we're stabilizing here, and again, troughs and recessions are best called in the rearview mirror, right? So we're not going to go that far at this point. But I think it's really encouraging that at this stage that we're stabilizing here. And it's really early to kind of call '25 at this point, but the fact that we're stabilizing here -- and the green shoots that I talked about are encouraging. Actually, the Dodge starts -- the new construction starts have turned positive this year and are forecast to be positive in 2024. As I mentioned in my remarks, that's good for '25 and '26. So I think we'll have to wait and see as some of this uncertainty in the back half of the year clears up to get a better picture to where we inflect and that's where we inflect in '25. But again, you've got to believe it's encouraging these signs for the overall commercial construction activity. Philip Ng Okay. And then transportation has been a nice tailwind for your AS business. Can you remind us how big transportation is for AS at this point percentage-wise? Vic Grizzle Well, for the overall business, it's about 10% vertical for us. So it's one of our smaller verticals, but just fortunately contributing to the Architectural Specialty part of our business. So we haven't broken it out specifically for our segments, but you can get a flavor, I think, for -- it's a nice contributor, a nice tailwind for the business. And your next question comes from the line of Rafe Jadrosich with Bank of America. Your line is open. Rafe Jadrosich Hi. Good morning. Thanks for taking my question. First, I want to -- the steel prices have moved down a lot so far this year. And I wanted to ask if you can remind us how that impacts your margins and earnings and you have volatility in fuel prices? And then also like how that flows through with the WAVE JV? Vic Grizzle Do you want to take the accounting side of this and just... Chris Calzaretta Yes. Okay. So Rafe, we basically WAVE has consistently been able to demonstrate price costs and actively manage monitoring and managing the pricing there. We saw some pricing in line with some inflation that we've seen in steel. And typically, it's about a quarter lag in terms of this deal coming in to this -- because it's actually running through and hitting the P&L. So it's not about a quarter lag there. But the business has been very successful in continuing to manage and drive AUV and drive that margin expansion by way of managing, monitoring steel and pricing accordingly. Vic Grizzle Yes. Let me just add because I think it's been a really good job by our WAVE team and the Armstrong selling organization to manage pricing because we did get some steel volatility, right? After the auto unions renewed in the last part of last year, November, December, we saw some really -- despite big spikes, I would say, in terms of steel pricing, we had to react very quickly. We raised price in December, which we very rarely do and then again in February to get out in front of it. And to your point, it's moderated since then. But our team has done a nice job to try to stay out in front of that. And Rafe you know well, that shows up through equity earnings, right? We -- the -- we look at the margin expansion inside that joint venture, but it shows up for us in terms of an equity earnings stream. Rafe Jadrosich Got it. That's really helpful. And then I wanted to follow up on some of the comments you had about on the green proven ground program. I know it just got announced, but can you just talk about like potential opportunity there longer term? And then do you have a sense overall, how much of your end markets in aggregate are tied to government spending or to government like real estate, just so we have this sense of the opportunity? Vic Grizzle Yes. This program is really exciting. There's a little over $3 billion earmarked for this program to go out and basically try to accelerate the pull-through of innovation that can drive decarbonization as well as energy savings. So -- and of course, the Federal Government just have a very large footprint, as I mentioned in my remarks. So this is a really exciting validating, brings a lot of credibility to the technology and should be an accelerator when we think about the adoption rate of the technology in the building construction market. So we're really excited about that. And again, we're in the early innings of that, but very excited to be part of it and the only ceilings company with this technology that's being considered. So very excited about that. The overall institutional footprint of the commercial construction market, we participate across all of these verticals where institutional plays. And since we're playing across all of those, I think it's fair to say that we're equally distributed across these verticals and participating in the institutional versus noninstitutional segments of the market. And your next question comes from the line of Stephen Kim with Evercore ISI. Your line is open. Stephen Kim Yes, thanks very much, guys. Just wanted to do a little cleanup on a couple of housekeeping items. First, in SG&A, I think you talked in or expect that, that was mostly related to the incentive comp with reform. So we're going to continue to model that, I assume for another three quarters, if I heard you right. Could you talk about the SG&A run rate in Mineral Fiber because that was also a little higher than we thought. Should we similarly expect that to continue here for another few quarters? And then you talked about some timing issues in working cap. Just wondering what those were, if you could just clear that up for us. Chris Calzaretta Sure. Let me go back to SG&A and start with Mineral Fiber -- so the SG&A comment was in terms of the total company with the overall contribution to SG&A being driven by the acquisition. If I go back to Mineral Fiber specifically based on your question, about $3 million in the quarter was due to higher incentive compensation. We did see then employee costs, higher employee costs due to inflation. And if I then go to AS, that was largely the impact from the acquisitions. So if I kind of take a step back and think about it from a run rate basis, it's more the acquisition contribution that sticks and is incorporated into the run rate going forward. On working capital, what we saw was timing related to accounts receivable, and that will work itself out here in the second half of the year. No issues from a collectibility perspective, that's not what this is. It's really just the timing of AR and the timing items that will reverse here in the back half. Again, confident about that and again, confident in our updated guide on adjusted free cash flow. Stephen Kim Got you. So just to make sure I heard you correctly on Mineral Fiber, the $3 million of -- due to higher incentive comp, you don't necessarily expect that, that's going to continue at that higher rate going forward? Is that what you're saying? Chris Calzaretta Yes. That was -- yes, that was recorded in the quarter associated with our performance. So no, not to that extent going forward. Stephen Kim Perfect. That's very clear. Second question relates to ProjectWorks in Canopy. Vic, you talked about Canopy sales up 20% project work running through there about 52%. And I guess what I was curious about is as we think about these digital initiatives broadly, should we be thinking them as a discrete driver to growth or more in the line of continuous improvement? In other words, is there a way to sort of assess how much incremental sales you're getting from these or you expect to get from these initiatives? Or is the benefit going to be seen more kind of just in margin or rather just a sustained advantage versus your competitors? Just trying to get a sense for how we should be thinking about that as longer term. Vic Grizzle Yes, it's a good question. And I understand the question, Stephen. For ProjectWorks, I think the best way to think about this is we're -- it's improving our engagement with architects and contractors to make them more efficient. It allows us, we believe, to help them realize their design intent more fully and maybe more uniquely with Armstrong solutions than others. So that really helps with both AUV and just kind of winning more of the specifications and holding on to the specifications. So may be the quality of the specifications improves. It's more on, I think, what you're asking around continuous improvement. That's probably the way to think about it, but it is additive in terms of our ability to drive higher value solutions into the marketplace because we've made it easy, right? And we've taken some of the risk out of it by -- through the ProjectWorks automation software. On the Canopy side, the incrementality is much higher, and we believe that we're tapping into a relatively untouched, underserved part of the market, smaller business owners that fall through the cracks, so to speak, don't know where to go or think it's too expensive to do renovation work, and we're helping them to accomplish the renovation they need to do through this platform. It educates them, kind of walk them through and then allows us to actually transact with them on the site. So that's more incremental is the way to think about that, both volume, and it's been positive on the AUV side as well so far. The healthy spaces and how this is evolving to be more complete, again, we had double-digit growth in our Healthy Spaces products in the quarter. That's really contributing to some nice volume growth. But again, I would put this one until we get the energy savings and the low embodied carbon, which have a real economic benefit to them until we get those with some higher traction in the market. I think you can assume that the healthy spaces initiative is really an EUV boost as well. So again, a lot of the technology that we brought to market to date has been really encouraging in support of continued AUV growth. And as you know, we -- AUV growth has been a hallmark of this business for over 10 years, consistently every year. And with the rate of innovation we're bringing around these platforms that we're talking about now, gives us a lot of confidence, we're going to continue to be able to drive AUV growth for the next 10 years. Stephen Kim Great. That's really helpful. Thanks very much for that. And your final question comes from the line of John Lovallo with UBS. Your line is open. Matt Johnson Hi. Good morning, guys. Actually Matt Johnson on for John. I appreciate the time. I guess, first off, that we could just kind of zone in on Mineral Fiber volumes in the quarter. They are up a little over 1%. Again, how would you guys frame the relative contributions from market demand versus AWI's outperformance? And then given your outlook in the back half implies volumes are down around 1%, again, how you guys think about the relative contribution from, call it, the market versus your outperformance versus the extra shipping base. Vic Grizzle Yes. So on the first two parts of that, the market is down in the low single-digit range. It's been kind of consistent there as we've been calling out the last couple of quarters. Our initiatives, our growth initiatives are offsetting to the tune of 1% to 2% has been, again, consistent contribution as they gain traction. So that low single-digit downmarket. And then the second quarter, we offset a large portion of that with a little bit of noise in the base period to compensate for that. So again, I'd say a very consistent market in that low -- down low single digits and then consistent contribution in the back half, we're expecting with our growth initiatives of 1% to 2% on the volume line. And on those shipping days, Chris, I'll let you... Chris Calzaretta Sure. So yes, we're up two shipping days versus the prior year and the back half of the year. So recall, in 2023, we saw higher retail activity than we've been talking about earlier this year in our guide for the full year and now incorporated in our guide for the rest of the year that some of that inventory is coming back out. So we assume that, that's going to happen and that largely offsets the additional two extra shipping days in the back half of this year. Matt Johnson Thanks for that. And then I guess based on the midpoint of your EBITDA guidance, it implies around $244 million of EBITDA in the back half could be up around $21 million year-over-year. So how is it that you guys are thinking about your EBITDA bridge in the back half when you guys look at volume, AUV, input costs, et cetera.? Vic Grizzle Yes. I mean when you think about the back half of the year, maybe just to hit it at a high level, really strong first half performance that does suggest a little bit of deceleration, I talked earlier on AUV. Again, expect to get strong like-for-like price to a lesser extent on AUV in the back half of the year. But at the end of the day, when you think about the other pieces, we're seeing a bit of benefit here in the first half of the year related to inventory valuations, and that's not going to repeat in the back half of the year. We saw an outsized benefit from our WAVE equity earnings in the front half of the year to a much lesser degree, obviously, in the back half of this year. So that's kind of how I think about the back half and the modeling associated with that. But again, feel good about our guide and what we have published for full year '24. And that concludes our question-and-answer session. I will now turn the conference back over to Mr. Vic Grizzle for closing remarks. Vic Grizzle Yes. Thank you, and thank you all again for joining. Again, I'm very pleased with the way our teams are executing and performing in this kind of sideways muted market, extracting as much value as we can and growing margins consistently. So really pleased with how we're performing and looking forward to a better outlook in our back half. So again, thank you for joining, and we'll keep you posted on our next update. Ladies and gentlemen, this concludes today's call. We thank you for your participation. You may now disconnect.

Earnings call: SBA Communications reports steady Q2 performance By Investing.com

SBA Communications Corporation (NASDAQ:SBAC) has reported a consistent second quarter performance, meeting expectations with strong operational execution and financial results. CEO Brendan Cavanagh emphasized the company's adaptation to the evolving market, marked by increased demand for network investment and the growth opportunities presented by mid-band 5G spectrum upgrades. Despite the headwinds from foreign exchange rates, particularly the Brazilian real, the company has managed to slightly increase its full-year projections on a constant currency basis. The services business experienced a notable 15% revenue growth from the previous quarter, and the international market results aligned with expectations. SBA Communications has declared a cash dividend of $0.98 per share, indicating a 15% rise from the previous quarter and showcasing the company's financial health and commitment to shareholder returns. Key Takeaways Company Outlook Bearish Highlights Bullish Highlights Misses Q&A Highlights SBA Communications continues to navigate the complexities of the global market, maintaining a strategic focus on growth and operational excellence. With a robust services business and promising international leasing activity, the company positions itself favorably in the dynamic telecommunications industry. Despite the challenges posed by currency fluctuations and the uncertain leverage outlook, SBA Communications' commitment to shareholder value and prudent financial management remains evident in its steady performance and optimistic projections for the coming year. InvestingPro Insights SBA Communications Corporation (SBAC) is not just navigating the market adeptly but also displaying strong financial signals that could be of interest to investors. According to InvestingPro data, the company's market capitalization stands at a robust $23.4 billion, reflecting its significant presence in the industry. Investors may also note the company's P/E ratio, which is 42.23, and when adjusted for the last twelve months as of Q1 2024, it is slightly lower at 32.86. This could suggest that the company's earnings are expected to grow, aligning with the InvestingPro Tip that SBAC's net income is anticipated to increase this year. Another metric that stands out is the PEG ratio for the last twelve months as of Q1 2024, which is at 0.85. This figure indicates that the company may be trading at a low price-to-earnings ratio relative to its near-term earnings growth, which is another InvestingPro Tip that investors might find valuable. With a dividend yield of 1.8% as of the end of 2024 and a notable dividend growth of 15.29% over the last twelve months as of Q1 2024, SBA Communications showcases its commitment to shareholder returns. This is further supported by the InvestingPro Tip highlighting that the company has raised its dividend for five consecutive years. For investors seeking additional insights, there are more InvestingPro Tips available for SBAC. These tips include the company's status as a prominent player in the Specialized REITs industry and its strong return over the last three months, with a price total return of 17.61%. To explore these tips and more, visit InvestingPro at https://www.investing.com/pro/SBAC and consider using the coupon code PRONEWS24 to get up to 10% off a yearly Pro and a yearly or biyearly Pro+ subscription. With additional tips listed on InvestingPro, investors can gain a more comprehensive understanding of SBAC's financial health and market position. Full transcript - SBA Communications Corp (SBAC) Q2 2024: Operator: Ladies and gentlemen, thank you for standing by. Welcome to the SBA Second Quarter Results Conference Call. At this time, all participants are in a listen-only mode, and later we will conduct a question-and-answer session. Instructions will be given at that time. [Operator Instructions] And as a reminder, this conference is being recorded. I would now like to turn the conference over to our host, VP of Finance, Mark DeRussy. Please go ahead. Mark DeRussy: Good evening, and thank you for joining us for SBA's second quarter 2024 earnings conference call. Here with me today are Brendan Cavanagh, our Chief Executive Officer, and Marc Montagner, our Chief Financial Officer. Some of the information we will discuss on this call is forward-looking, including but not limited to, any guidance for 2024 and beyond. In today's press release and in our SEC filings, we detail material risks that may cause our future results to differ from our expectations. Our statements are as of today, July 29th, and we have no obligation to update any forward-looking statement we may make. In addition, some of our comments will include non-GAAP financial measures and other key operating metrics. The reconciliation of and other information regarding these items can be found in our supplemental financial data package which is located on the landing page of our investor relations website. With that, I'll now turn it over to Brendan to comment on the second quarter. Brendan Cavanagh: Thank you, Mark, and good afternoon. The second quarter was another solid one with good execution operationally and financial results in line with our expectations. Accounting for recent weakening in foreign exchange rates, we have modestly lowered our full-year outlook for most financial measures. However, on a constant currency basis, we have slightly increased our projected full-year results. The year has largely unfolded as we had expected. Steady carrier activity across our markets, but no material inflection in new lease and amendment executions thus far into the year. In the US, we have continued to receive increased inquiries from our customers, which is a good sign, but to date we have only seen a modest increase in new business executions. Looking out over the next several years though, we are very excited about the prospects for further increased demand. Mobile network consumption continues to grow at a very healthy pace, adding strain to existing networks. The offering of fixed wireless access by all three of our major customers will only add to this network strain. I have mentioned it before but I believe it bears repeating. The average fixed wireless access user consumes 15 to 25 times the data that a typical mobile wireless user consumes. As a result, the equivalent mobile subscriber additions to our customers networks is significantly higher than it has been in the past. This phenomenon will require continued network investment by our customers to keep pace with the demand. And all have publicly discussed plans to continue to grow fixed wireless access subscribers over the next several years. We also expect that the eventual incorporation of new Generative AI capabilities into handsets will further increase network consumption. In addition, the percentage of our existing leases with the big three carriers that have been upgraded with mid-band 5G spectrum still remains at just over 50%, leaving a significant growth opportunity ahead of us. Varying rates of 5G progress among our largest customers creates competitive pressures that we believe will also be a driver of future network investment, just as it has been in past cycles. Incidentally, mid-band 5G spectrum upgrades in our international markets are at even lower percentages of completion than in the US. Beyond all these demand-oriented drivers, we expect increased network spending driven by 5G coverage commitments made in connection with past regulatory approvals. Some of these commitments not only require coverage of POPs, but also minimum downlink speeds. This means that denser buildouts and expansion into areas not previously prioritized, particularly rural areas, will become more important as deadlines approach. We believe we are well situated to assist our customers in meeting their objectives with both our assets and our services support solutions. We are in the business of long-term assets and long-term customer relationships. Things don't change materially overnight, but the signs of numerous demand drivers are all there, and we are confident in our long-term organic growth prospects. In our services business, we had another good quarter as well. Revenue was up 15% from the first quarter and our gross profit contribution was ahead of our internal expectations. We have lowered our full year outlook for services revenue by $10 million at the midpoint due to a lower anticipated level of construction work, although we still expect to increase that number in the second half of the year over first half levels. Notwithstanding this lowered revenue outlook, we have not reduced our expected gross profit contributions to our full year adjusted EBITDA outlook as we continue to secure higher margin work. Our services teams continue to perform very well for our customers, helping them to significantly reduce their deployment cycle times. Internationally, results were also in line with expectations in the prior quarter, although we did see a pick-up in new leasing activity during the quarter, increasing the contribution to full year revenue from new leases and amendments. Each of our markets has opportunities for increased organic growth as new spectrum and new generations of wireless technology are rolled out. Challenging macroeconomic factors and imbalanced market share among mobile network operators in some of our markets has led to consolidations and increased network rationalizations, presenting some near-term challenges, but ultimately bolstering the strength and sustainability of our customers' prospects. We continue to work toward enhancing our own market positioning and our alignment with the leading carriers in each of our markets. We believe our efforts will ultimately enhance the long-term strength and stability of our cash flows and increase our opportunities to capture incremental organic leasing revenue growth. During the second quarter, we also continued a balanced approach to capital allocation with a mix of portfolio expansion, stock repurchases, dividends, and debt reduction. I anticipate that we will continue to balance our capital allocation for the remainder of the year. Since our last earnings call, we have largely focused on debt reduction and have reduced our outstanding revolver balance to just $30 million as of today. We have some upcoming debt maturities that we anticipate refinancing in the near future. But until that time, we will likely continue to prioritize debt reduction and liquidity. The debt markets are wide open to us and have also improved over the last few months as we have seen some tightening of rates. Our quarter-end net debt to adjust to EBITDA leverage ratio was 6.4 times. So, while our current priority is debt reduction, we have preserved the flexibility to take advantage of material value enhancing investment opportunities if they arise. We continue to explore and stay educated about the numerous asset portfolios available throughout our markets, but we'll retain an informed financial discipline in our approach to these opportunities. Our approach has really not changed, but our increased cost of capital has certainly underscored the emphasis we place on precise valuation and strategic rationale. I still believe we are the best in the business at valuing, integrating, and operating tower assets. So I believe we can continue to create value through asset acquisitions. We have a great long-term steady cash flow, low-risk business. The underlying strength of wireless dependent products and services will continue to drive increased needs for enhanced infrastructure solutions, and we have positioned ourselves as a key partner for our customers in meeting the challenges of addressing those needs. Before turning it over to Marc to share some more specifics on our second quarter results, I'd like to thank our team members and our customers for their contributions to our success. With that, I'll now turn things over to Marc who will provide additional details. Marc Montagner: Thank you, Brendan. Our second quarter results were in line with our expectation. Second quarter domestic same tower revenue growth over the second quarter of last year was 5.9% on a gross basis and 2.3% on a net basis, including 3.6% of churn. $8.2 million of the second quarter churn was related to spring consolidation churn. International same tower recurring cash easing revenue growth for the second quarter, which is calculated on a constant currency basis, was 2.7% net, including 5.3% of turn, or 8% on a gross basis. In Brazil, our largest international market, same-tower gross organic growth was 6.4% on a constant currency basis. As compared to the previous quarter and full year 2023, the reported international growth rate continued to be impacted by a declining local CPI link escalator in Brazil. We continue to see strong organic leads up in our international market. Total international returns remain elevated in the second quarter due mostly to previously announced carrier consolidation. During the second quarter, 79% of consolidated cash site leasing revenue was denominated in US dollars. The majority of non-US dollar denominated revenue was from Brazil, with Brazil representing 15.1% of consolidated cash site leasing revenues during the quarter. Let me now cover our revised outlook for 2024. Excluding the impact of weak foreign currency assumptions, we slightly increase our full outlook for site leasing revenue, tower cash flow, adjusted EBITDA, AFFO, and FFO per shares compared to our prior outlook. The devaluation of the Brazilian real versus the US dollar is estimated to have a negative impact to our site leasing revenue of approximately $19 million in 2024 versus our prior forecast in May. With regard to site development revenue, we are forecasting lower construction volume for the full year and therefore have lowered our full year outlook by $10 million. However, we have not reduced expectations for gross profit contribution for this business as we continue to execute well and secure higher margin work. Please also note that the outlook does not assume any further acquisition beyond those as of today that are already under contract and expected to close by year-end. We also do not assume any share repurchase beyond what was already completed so far this year. However, it is possible that we invest in additional assets or share repurchase or both during the year. Outlook for net cash interest expenses and core FFO and FFO per share now assume a September 1st refinancing of the $620 million ABS Tower Securities scheduled to mature in October 2024. We assume that we're financing at a fixed rate of 6% per year. Actual rate and timing may vary from these assumptions. As a result of this revised financial assumption and projected lower cash taxes, a full-year FFO per share outlook has increased by $0.09, excluding the impact of FX changes. Let me now turn the call over to Mark. Mark DeRussy: Thank you, Marc. Our balance sheet remains strong, and we have ample liquidity. Our current leverage of 6.4 times net debt to adjusted EBITDA remains near historical lows. Our second quarter net cash interest coverage ratio of adjusted EBITDA to net cash interest expense remains very strong at 5.2 times. Our weighted average maturity is approximately four years with an average interest rate of 3% across our total outstanding debt. Including the impact of our current interest rate hedge, the interest rate of 97% of our current outstanding debt is fixed. We continue to use cash on hand to repay amounts outstanding under the revolver. And as of today, we have a $30 million balance under our $2 billion revolver. In addition, during the quarter, we declared and paid a cash dividend of $105.3 million, or $0.98 per share. And today, we announced that our Board of Directors declared a second quarter dividend of $0.98 per share payable on September 18, 2024, to shareholders of record as of the close of business on August 22, 2024. This dividend represents an increase of approximately 15% of the dividend paid in the second quarter of 2023. And operator, with that we are ready to open up the call for questions. Operator: [Operator Instructions] And our first question will come from David Barden with Bank of America (NYSE:BAC). Please go ahead. David Barden: Hey, guys. Thanks so much for taking the questions. I guess the first question, if I could, maybe either for -- I don't know who this question goes to. Just talking a little bit about the evolution of the financing market, there's been a lot of movement in the last few weeks. You guys took some steps to try to maybe pre-finance the term loan coming due in 2025. I'm wondering if you could kind of comment a little bit about what the landscape looks like and how the rates that you are being presented look relative to what they might have looked like a month ago? And then if I could, the second one is, just for our, just as a reminder, Marc or Brendan, when we think about how you guys choose to budget FX into your guidance, with the real blowing out to like BRL5.60, are you looking at forward rates? Are you looking at spot rates? How are you deciding what you're going to bake into guidance, which seems to be the biggest moving part in what happened this quarter? Thanks. Brendan Cavanagh: Yeah. I'll jump in first, David, and Marc can add in anything that he thinks I need to -- that I missed on the financing market. The market certainly has been improving. Obviously, there's a greater expectation in terms of rates. The next financing -- the refinancing that we have to do are of ABS debt that's outstanding. And we expect to do that with a like instrument and those instruments are typically priced as a spread to treasuries. So the improved general sentiment around forward rates affects the treasuries and that obviously is helpful to the potential pricing of those financing that we have ahead. But just beyond that, there's a high demand for the type of paper that we issue. And I think there's opportunity to see that continue to improve moving forward. As it relates to the term loan that we did before, it's floating rate, so really that didn't change much and we had a hedge in place. So obviously an improving rate environment will directly help that particular instrument, particularly when the hedge falls away next year. So on the second question regarding the FX forecasting, we typically will use as we go into the year, a forward market. We'll look at what are the general consensus of projections for that year, primarily around Brazil, around all of our foreign currencies, but Brazil is the biggest one. And we will usually pay it to that. Unfortunately, those projections have not turned out to be right thus far this year, and the currency has weakened much more than was originally expected. And the rate that we're using now for the balance of the year is pretty close to spot, which is also in line generally with projections, but obviously it's an inexact science. So we would prefer to try and nail it right on and not have to change it, but that's a hard task. Simon Flannery: Great, thank you very much. Good afternoon. First, on M&A, you put this comment in about taking advantage of material value, enhancing investment opportunities as they arise. Has something changed that you're looking more closely at that now, maybe given you get through some of this financing, or is it just consistent with where you've been before? And any thoughts around how you're thinking about geographies? I know you talked before about Europe being interesting, but is it mostly developed market or US and Europe or would you look at expanding and existing or new developing markets? Thanks. Brendan Cavanagh: Sure. Yeah. The comment about material value enhancing, obviously that's not different than what we've done in the past. I think the key difference now is that with our leverage having come down to a much lower place, actually the lowest place it's been in our history, it allows for flexibility that if we saw something of material size that we thought would be value enhancing to be able to transact that maybe easier than it would have been in the past. But our approach is not that different. Obviously, cost of capital is higher, and so that affects what we can pay or where we see value in terms of the opportunities that are out there. But it's our goal and intention to hopefully find opportunities that are creative and add other value, even strategic value in terms of positioning to the extent it's in international markets for example. And I think you should expect that we're constantly looking and that hopefully we will find those opportunities just as we've done in the past. In terms of the where, it really depends. I mean, mostly we're focused on the markets that we're in, but we kind of scour the globe and we look at everything that's available. We look at opportunities that are in markets we're not in, because sometimes we see things that we think will fit very well and will be long-term value creating. So there's not a specific target, but to the extent that we can add in markets where we already are, there's obviously some synergies associated with the operations around that. Simon Flannery: And do you think we're getting to a better place between private and public multiples? Because it seems like they've been quite a spread there for a while. Brendan Cavanagh: Yeah, I think it's moving more in the right direction than it has in the past few years. Specifically internationally, I would say we're seeing that constrain meaningfully in terms of the difference between the twp. Domestically, it's probably less so, and I think that's mostly a function of just limited supply in the US. And obviously, it's kind of the prime tower market. But even in the US, I'm starting to see some indications that maybe that gap will narrow a little bit. Jim Schneider: Good afternoon. Thanks for taking my question. First of all, could you maybe tell us how you're thinking about the various international markets where you have a presence already today? Any attractiveness of staying in markets where you arguably are subscale relative to getting bigger in ones where you already have a meaningful presence? Brendan Cavanagh: Sure. Yeah. As we mentioned it at the beginning of the year on our first call of the year about our approach, that we're doing a review kind of all of our not only our international markets but all of our business lines. But specifically as it relates to our international markets, what we've determined as we kind of look through it is it definitely is an advantage to be of greater scale, to be of more relevance to your customers in the markets that you're in. And in some places we are in that position, and in other places we are not. And so, to the extent that we can solve that issue through expansion in some of those markets, we would like to do that. If we do not see a reasonable way to do that, then we may look to move on from certain markets as we've done, at least with one in the past. So we're continuing through that exercise, and even though there's no real update on that at the moment, it's not because there's no progress being made, there is in fact a lot of progress being made, but we're not at a point to be able to discuss specifics yet, but we will be down the road. So ideally, we'll look to be able to have a good scale in each of the markets that we're in, and we'll also look to be aligned with the stronger carriers that are operating in those markets as well. Jim Schneider: That's helpful. Thank you. And then maybe as a follow-up, relative to the downtick in site development expectations for the year, I know that's not impacting the gross profit line because you're picking more profitable business, but can you maybe just comment on what that signifies in terms of domestic care activity, broadly speaking, and whether that's any kind of leading indicator of a more of your environment, or is that just you being selective in the business you're taking from them? Brendan Cavanagh: Yeah, I don't -- it's not really signifying much. It is -- the mix of work that we're doing is a little bit different. It's a little more oriented towards consulting or site development services type of business as opposed to construction. So the top line volume ends up being lower, but the margin ends up being higher on that. And our outlook, although it is lowered in total for the year, and that's really based on the first half of the year, honestly, we expect the second half of the year, and it's implied in the number, to be higher in terms of the volume than the first half of the year. So I wouldn't say that it's necessarily a sign of it being more muted. I think it's just the mix of work as much as anything. Operator: And our next question comes from Michael Elias with TD Cowen. Please go ahead. Michael Elias: Great. Thanks for taking the questions. Two, if I may. First, there are a few assets on the market in Europe right now. I'm just curious, at a high level, could you give us your thoughts philosophically on the European tower market? Maybe if you could compare and contrast the opportunities and headwinds for that market. And then my second question would be, just based on everything you're seeing domestically at the moment, do you believe we can see domestic new leasing in 2025 be up versus 2024 levels? And kind of, if not, when is the drop dead for us to see a pick-up in activity for it to really be reflected in 2025? Thank you. Brendan Cavanagh: Sure, I just -- I'll do the second question first. I mean, we're obviously not in a position today to give outlook on 2025, so I don't really want to get into that too much. And so much of what '25 will look like is going to be based very heavily on what we see happen in the second half of '24. So I would say just hold tight and we'll see how that goes. If we don't see any real uptick in carrier spending in the second half of 2024, then it likely would not be up, but there's still a lot of that story to be written, so we'll see where it goes. On your first question on Europe, we obviously don't have any operations in Europe. So my views and opinions are based on just looking at it from the outside in. We've explored opportunities as they've come up in Europe. And I think the positives there are obviously you've got a very stable type of market in terms of currency, in terms of rule of law and regulations. It's very established. But it's also slow growth and I think there are some churn risks that exist there, particularly as you see carriers consolidating their network operations. And so, any decision to expand into Europe will be opportunity specific and dependent upon the valuation as much as anything and what we see as the specifics around that particular portfolio if we decide to go that route. So yeah, we look at everything that comes available as I said earlier and if we see something we'll explore it. And if we don't, then we're perfectly content where we're at. Richard Choe: Just wanted to ask on the leverage. It's continued to go down and it seems like it'll continue to trend that way given if there's nothing out in the M&A environment. How low could we see that leverage go to over the foreseeable future? Thank you. Brendan Cavanagh: Sure. Well, it's not our intention to necessarily see it continue to go lower. That's really going to be a function of the alternative uses of capital. So I can't give you an exact number. I think depending on the opportunities that come along for investment into the business and to assets, that will be the main driver of where leverage goes. If we see an opportunity to expand in a way that we think will be value additive to us long term, then you may see leverage tick back up. If we don't see that, then leverage will probably continue to decline. Eventually, we'll have to explore what that means in terms of investment grade, but I don't think we're quite there yet. Richard Choe: It seems like the opportunities have been a little bit slow in the first half of this year. Do you think things will pick up in the second half and as we go into next year? Brendan Cavanagh: Yeah, I would not say that they are slow. I would say that nothing has been secured, certainly signed up or closed as of yet that's of a major scale, but there are a lot of different portfolios and opportunities out there. So I think my M&A team would not agree with that it's slow because they've been very busy. But what that ends up resulting in will depend on whether we can find something we like in terms we find attractive. Operator: Our next question comes from Ric Prentiss with Raymond James. Please go ahead. Ric Prentiss: Hey. When you get quarters, like most recently, with the FX rate, does it cause you to pause a little bit and think, why are we so heavily involved in some of these international countries? Or how should we think about what moments like this when you have to pull down the guidance because of FX to David's questions earlier? How do you kind of square that with where you want to see the company go longer term? Brendan Cavanagh: Yeah, I think, Ric, it's a -- obviously, we have what we have. We have a big embedded business, particularly in Brazil, and it's got that risk, and we've seen it in past cycles, too. And, of course, it's disappointing to us to have to lower outlook based solely on that particular issue. I think it does impact or influence the way that we think about the mix of our asset base and our revenue base to have something that's a little more stable. I think at the beginning of the year when we were talking about our overall goals and the way that we look at things, stability was kind of a key point in that. And obviously, this particular item introduces an element of instability that I would prefer not to have. However, we have a very good business down there. There's a lot of good things that are going on in Brazil. And so trying to navigate through the right way to reduce that exposure probably comes through increased exposure in other places that perhaps have more stable currencies. So we'll see if we can do that but I would say that it at least influences us to not get too overextended to some of these currencies that have greater volatility. Ric Prentiss: Makes sense. And you had a comment earlier that the US is still about 50% done on the mid-band deployment varies by carrier significantly possibly and international as well. Can you give us kind of a spot number? Where are the international markets on kind of that mid-band or 5G spectrum deployment? Brendan Cavanagh: Yeah, I do have that and it does vary by market and I think maybe something we can share with you offline because I don't have it right in front of me. It's kind of a mix, but I would say, this is me ballparking it based on what I've seen for each country that we've got. You're looking at somewhere in the probably 25% or less on average across all of the existing international markets that we're in. Ric Prentiss: Okay. And then Simon asked a question about public versus private multiples. Take that a little bit further. And what are the pros and cons of maybe selling a piece of your domestic business if private multiples stay above public multiples, i.e. American Tower (NYSE:AMT) did it with the Telxius European, did it with core data centers. So it's kind of a way to bring capital in, could be used to address the balance sheet. But kind of your thoughts, pros and cons on kind of that disparity between public and private and that maybe you could sell, buy high, sell low, kind of find a place to say, well, can we get [them mark] (ph) to market? Brendan Cavanagh: Yeah, I think that's never been a big part of our goal is to shrink through selling off assets. I think certainly, partnerships that bring in partners is a possibility that we would consider. But in terms of selling assets, I would say it's on the table, Ric, if in fact evaluations are just at a level that we believe is clearly well above the credit that we're getting for those assets, but there's a lot of logistics that we would have to work through as well. We obviously have financing structures, we have MLA agreements, we have a number of different things that would impact our ability to kind of hive off assets here in the US. But I wouldn't rule it out altogether. I just would say that it's not at the top of the list ideally. Ric Prentiss: Makes sense. It's complicated, but something should be at least studied. Brendan Cavanagh: Yeah, and maybe just one other thought on that as I'm thinking about it. We always talk about the disconnect, and I think the inference is always that the disconnect is that the private multiples are too high, I might flip that around and suggest that the public multiples perhaps are too low. So it's not -- when it closes, which way it closes will obviously have an impact on how you feel about that sort of an exit. Ric Prentiss: Exactly. I know we agree with that and that sometimes a mark to market wakes the public up to what the real value is. All right. Hey, appreciate it, guys. Thanks. Operator: Our next question comes from Jon Atkin with RBC. Please go ahead. Jon Atkin: Thanks. Two questions. One, anything about the build-to-suit opportunity, given your recent run rate of domestic builds-to-suit, and anything that you see that might cause you to want to get a little more aggressive on that? And then on the leasing side, I think I heard you say increased interest, some of it due to mandated kind of rural build-outs. Anything attributable to FWA, you mentioned that in your remarks, but anything yet apparent in your leasing pipeline that you would attribute to fix wireless access? And then I've got to follow up. Thanks. Brendan Cavanagh: Okay. Yeah. On the BTS, I think you said, if I heard you correctly, you were talking specifically about domestic builds, John? Jon Atkin: Yes. Brendan Cavanagh: Yeah. I mean, we would like to do more of those certainly. I mean obviously you've seen our numbers over the last few years. They haven't been particularly heroic and a lot of that's because the carriers have tended to go to low-cost providers because that's a choice that they have because there's so much capital out there supporting this particular industry. So we would like to do more. We found a way to do that though is to secure high quality locations to get out ahead of where coverage needs are and secure those opportunities in more of a strategic manner as opposed to pure build astute, although we do some of those still. But yeah, I'd like to be more aggressive on it, for sure. I just don't know if we're going to get to numbers that really move the needle too much. In terms of our backlog and the fixed wireless access influence on it, it's hard for us to say exactly, because fixed wireless access is typically using the 5G oriented mid-band spectrum that is being deployed more broadly. And so I think to date, most of these fixed wireless subscribers have been supported through excess mid-band spectrum that's been deployed, capacity on that spectrum that's been deployed already but it's starting to get closer to a point where that's going to be harder to do because of the amount of consumption for that particular product. So I can't draw a direct line to it yet, but we see signs that the customer's networks are going to become more and more congested as a result of that product, and that ultimately is very good for us. Jon Atkin: And then AMX seems to have kind of increased as a percentage of your international leasing. Anything around their activity level, or is it a matter of other operators maybe moderating their activity, any color there? Brendan Cavanagh: Yeah it's actually Two things. It's one, they have been very active, they've probably been our most active leasing customer broadly across our international markets. But two, with the FX decline in Brazil, they are obviously a tenant there but they have a presence in a number of our other markets, so they're not as affected as some of the other carriers on that list that we share. So their percentage just by default comes up as a result of the FX shift. Jon Atkin: And then lastly, I've got a question on the balance sheet. Is it -- would it make any sense to utilize your revolver to pay down the ABS debt and then see kind of what happens in terms of Fed cuts later in the year and wait to issue ABS after that? Brendan Cavanagh: I mean, it could, although you're really making a little bit of a bet because if you're using the ABS market to refinance the existing ABS debt, you are using a benchmark rate that implies a certain expectation around the rate. It's not directly affected by when the Fed cuts, if they cut. So if you were to say, well, I'll hold off and take my chances and do it down the road, the revolver will be priced at a higher rate. So for the time being, you will be paying a much higher rate than you otherwise would. And so does it make sense? Plus we have other financings maturing, one big one in January and then others in January of '26. So you can only do that for a limited period of time. So I'm kind of inclined not to think about it that way. But the good news is, we have tremendous liquidity and we can be flexible if necessary. Michael Rollins: Thanks and good afternoon. I had two questions. First, with respect to the domestic carrier conversations that you referenced, can you share if those are related to the typical a la carte business that you've seen from your carrier customers, or are these discussions possibly getting you closer to signing additional comprehensive MLAs with additional national wireless carriers? And second, is there any change in timing or magnitude of the anticipated multi-year churn from mergers and industry rationalization for both the domestic and the international segments? Thanks. Brendan Cavanagh: Sure. Yeah, I mean the conversation -- we're in regular conversations on a daily basis at all different levels with our carrier customers. And so, conversations cover a wide variety of topics and those certainly include the potential for larger, broader deals, but I wouldn't say that that is the sole focus for the time being. We're operating under the existing agreements that we have in place. We do have existing MLAs in place. Some of those involve a la carte type of arrangements, but they define those pretty well. So we continue with business as usual on that front and try to figure out where our customers could use our help the most in terms of their broader, bigger picture initiatives. And if that's best served through an MLA, we're open to that as a possibility. On the timing and the magnitude of the churn from the consolidations, it hasn't really changed too much. I think we tweaked our churn outlook in the US up just slightly, and that had to do basically with the timing of some of the Sprint churn being slightly earlier, but these are really fairly small changes in terms of the overall expectation, for instance, around Sprint. It hasn't changed from what we've given out in the past and I think was reiterated by Marc in his comments earlier today. And internationally, that's generally the case as well. The one thing that could change that is if we were to reach some sort of agreement, specifically with Claro around their Oi wireless overlap in Brazil that pulled forward or changed the timing for some of that, that could obviously have an impact. But as of today, it continues along the same path as we previously laid out. Operator: Our next question comes from Brandon. I apologize. Our next question comes from Nick Del Deo with MoffettNathanson. Please go ahead. Nick Del Deo: Thanks for joining my questions. First, regarding the pickup in new leasing activity overseas that you cited, can you drill down on that a little bit? Is it coming from a particular market or markets? Does it feel like a blip or the start of something more sustained? Any color there would be great. Brendan Cavanagh: Yeah, it's -- I would say that it was across a number of our different markets. I mentioned earlier that Claro was busy. They were a big driver of that. And yeah, I can't say for sure whether it's to be sustained, but our backlogs continue to be pretty strong. And so I hope that in fact it will be. I think there's a lot to do as we look at the needs that these carriers have. It's really more of a financial question, I think, than anything else. So I think it's a good sign to see it ahead of the pace that we expected to be at, at this point. And at this point, I think that that will continue throughout the balance of the year, and we'll let you know where we are as we get into next year. Nick Del Deo: Okay. And then to follow up on some of the M&A questions, there might be a couple good sized portfolios for sale in the US. I guess, given your current size, 17,500 towers, do you think there are still meaningful strategic or cost efficiency or other benefits to having greater scale in the US? Or do you feel like, given your scale, for all practical purposes there aren't scale driven benefits to be had from a potential deal of those sizes? Brendan Cavanagh: I think from an operational standpoint that the scale benefits are very limited because we're pretty streamlined at this point. I think there are some certainly but I think it's relatively small part of any large scale deal that we would do here in the US. But there probably are some benefits in terms of just being able to help our customers achieve some of their broader reaching goals if we have a bigger portfolio. That does make a little bit of a difference, I think. But I don't think it's a major factor. I think ultimately they'll need the sites that they need, and we have a lot of great sites and a lot of great locations that are frankly ones that can't be duplicated. So it's something that we would think would be marginally beneficial from a strategic standpoint but marginally being the key word. Nick Del Deo: Okay. Appreciate that. Thanks, Brendan. Operator: And our next question comes from Brandon Nispel with KeyBanc. Please go ahead. Brandon Nispel: Great. Thanks for taking the question. Brandon, you mentioned the US increase in the -- moderate increase in new business execution. Can you comment... Brendan Cavanagh: Brandon, I'm sorry. You were muffled there. I couldn't really hear what you said. Brandon Nispel: All right, so you, Brandon, you mentioned increased increase and modest increase in new business execution in the US. Can you say the same for your backlog of lease applications? Is it up or down versus this time last year? Then as we look at the guidance for the rest of the year, it looks like from a new leasing standpoint in the US, it does imply lower in the second half versus the first half. Are you at the point where you can say with confidence that leasing has troughed or is it potential that we see leasing below this $42 million level for next year based on the application pipeline that you have? Thanks. Brendan Cavanagh: Yeah, I can't give you next year's numbers at this point. I would tell you that from an application standpoint, we have seen increases. Each of the last couple of quarters, quarter-over-quarter, continues to go up, so that's a good sign. But an application doesn't necessarily tell the whole story because you have to see how that plays through and what's the level of equipment that they're installing and so forth. I do think with the increases that we're seeing in terms of interest and applications that we'll see an opportunity to have greater executions as we move through the year, particularly into next year. But there's so much that still has to be -- has to play out for us to know what that does to next year's number that -- it's premature for me to say. Brandon Nispel: Got it. And could I follow up? On the services guidance cut, last year, and historically T-Mobile's been north of 70% of that business, can you say that the client and services guide was broad, meaning more than one customer, or was it concentrated in one customer? Thanks. Brendan Cavanagh: Yeah, I would say that it was broad in the sense that it was across the customers that make up that revenue base, although we do have certain concentrations. So obviously it's a greater absolute dollar amount from certain carriers. But there's nothing that stands out about that. It's really more, as I said earlier, it's really more about the mix of work being a little more SDS related instead of construction related. Matt Niknam: Hey guys, thank you for taking the questions. Just two follow-ups. First, I guess to the topic of carrier activity, any changes in activity or uptick in conversations with DISH? And then secondly, on the operational review of the business, I know it was a bigger topic last call and I know it sounds like there's more going on behind the scenes, but is there's any initial findings or when we can anticipate more meaningful updates on that front? Thank you. Brendan Cavanagh: Sure. On DISH, there's been -- we continue to have conversations. They actually do continue to sign leases with us, but there hasn't been any material inflection in that. And we're waiting to see how their plans evolve, if they evolve. I'm sure there are conversations ongoing in terms of the deadlines around their commitments for coverage for next year, and financing, and a number of other things. But we're just here trying to be the best partner we can be to them on their needs. And they continue to sign leases in places where they need it, but it's obviously at a lower level than it was a couple of years ago. So nothing really new there. On the strategic or operational review, yeah, there's only so much I could say at this point because we've done a lot of work, but until we're ready to share with you specific takeaway, specific actions that are being taken, it would be premature for me to talk about that right now. But I do think certainly by the end of the year, I would expect that there will be a number of things that we can share. Brendan Lynch: Great. Thank you for taking my question. It seems on a number of fronts you're in sort of de-risking mode, reducing leverage, considering going at investment grade, exiting some non-core markets. How should we think about your risk tolerance going forward over the next few years relative to what it's been over the past few? Brendan Cavanagh: I think it will be an informed amount of risk. There's always some degree of risk, particularly when you're making decisions to invest capital and expand by buying or building new assets. So I believe that all of the learnings that we have over the years and what we've seen in each of the markets where we operate make us better informed to understand the risk that we're taking on and to manage and frankly price that in in any decisions that we make. So I don't know that it's changed a lot. I think the knowledge that we have changes every day and that informs it, but our overall risk tolerance is probably not that different, just our education is a little different. Brendan Lynch: Maybe just to dig in on that a little bit more. Obviously, there's been changes in the cost of capital and the opportunity set. But maybe talk about those dynamics also in the context of just the maturity of the market and how much risk you're willing to take to pursue the next level of growth that might be available. Brendan Cavanagh: Yeah, I mean, so much of the decisions around investments in the new assets is impacted by your view of the future of those assets in the markets and what are the M&Os in those particular markets going to be doing and what are their needs going forward. And I think almost in every case, when one tower company buys a portfolio instead of another, it probably comes down typically to their view of the future. And one has maybe a slightly more favorable view than another, and therefore they are able to see their way clear to pay a little bit more. And I don't think things are any different than that today. Obviously, the cost of capital being higher makes a difference, but it's higher for everybody. And I think that's what started to normalize. It started to make its way through the system, whereas before you had certain folks who were using capital that was priced at a much lower point, and that was allowing them to continue on buying stuff at prices that were suddenly becoming not as attractive to some of us that were affected more quickly by the change in cost of capital. So I don't think it's any different. I think it's just a matter of everybody adjusting to the cost of capital and then how you see your way clear to obtain the growth necessary on the assets that you're buying. Operator: Our next question comes from Ari Klein with BMO Capital Markets. Please go ahead. Ari Klein: Thank you. Maybe just going back to the carrier inquiries you alluded to, is there any additional context you can provide as to how they've changed and how typical or atypical is it for these conversations to ultimately materialize in better leasing? Brendan Cavanagh: Well, they change in the sense that, at a given point in time in a given market a carrier has more or less initiatives, certain specific needs. They either have them or they don't in a given window of time. But that's not really different than the history of it. It's just as cyclical in different places. So I don't think that the conversations are necessarily that different. I think when they change more meaningfully is when there's a big initiative, a big project, a new spectrum band to roll out or a particular initiative that is carrier specific and that will lead perhaps to maybe a bigger scale agreement, that sort of thing. But the conversations inform our view on where they're going and allow us to better position ourselves in order to capture a greater percentage of the business that's going to come as a result of those initiatives. Operator: Our next question comes from [Jonathan Chaplin] (ph) with New Street. Please go ahead. Jonathan Chaplin: Thanks, guys. It's Jonathan Chaplin. Two questions, if I may. You mentioned earlier that if you didn't secure attractive assets, that your leverage might continue to tick down. Of course, you could repurchase shares. And I think you also said earlier that you thought the public multiples are too low. Your stock is undervalued. So it's the reason that leverage would tick down. But for asset acquisitions that don't include your own assets, it sort of indicates that you think it's probable that you're going to pick up a decent sized portfolio in the relatively near future. Otherwise, you'd be buying back stock. Or rather, buying back stock and keeping leverage constant. Brendan Cavanagh: Well, yeah, I didn't say that we are definitely buying a material portfolio. I'd say that we are looking at all kinds of things that are available. And some of those include material portfolios. But whether those happen or not remains to be seen. So sometimes you have to be patient in terms of how you use your capital. We've in the past had people say, well, you must not like your stock because you didn't buy it this quarter. Well, that's not necessarily true. It depends on other things that are going on that take a lot longer than one or two months to determine how they're going to play out. So I think what you should expect is going forward, we will over time have a mix of all of these things. We will do buybacks, we will do debt paydowns, and we will also hopefully buy assets. Jonathan Chaplin: Got it. And then on a completely different track, which markets do you feel like you're subscaling? And what was sort of different about the thesis when you entered that market versus how it's played out in terms of, did you expect there to be more organic growth in those markets or more portfolios to come up for sale or the portfolios that did come up for sale came at prices that you weren't willing to compete for? Brendan Cavanagh: Yeah, I think in the past when we first were entering certain of these markets, our view on scale was that scale is reaching a point that you cover your overhead and you produce positive EBITDA. And I think where our view has evolved is that scale is more than that. It's your relevance to the leading carriers in the market and if you don't have that and in particular international more than this is the case in the US internationally, if you don't have that the way that work is handed out, the way that carriers engage with providers, tower providers in this case, is influenced by the relative importance to their network that you represent. And so we have some places where we simply have small portfolios and there are much bigger players. And so we either need to figure out how to become a bigger player that's more relevant to our customers or we shouldn't be there. Operator: Our next question comes from Batya Levi with UBS. Please go ahead. Batya Levi: Thanks. A couple of follow-ups. First, on the domestic side, normal churn is still running at the high end of 1% to 2% you've laid out. Do you see some opportunity to lower that to the low end? I think some of your peers are suggesting it. And a reminder on the exposure to US seller would be good and how long you have left on that contract? And lastly, SG&A stepped down sequentially, can you talk about if that level is sustainable going forward? Thank you. Brendan Cavanagh: Sure. The opportunity for lower domestic churn, yes. I do think that excluding, of course, Sprint or any other material consolidation that might take place that we would see that number trend down over time. A lot of that was made up of stuff that was smaller companies and that kind of thing. So, I expect to see less and less of that. But we'll see as we get into next year and the years beyond. US Cellular, we have a fairly immaterial exposure. We have less than $20 million a year in revenue from US Cellular and even, obviously a smaller percentage of that overlaps with T-Mobile. So I don't think it'll be overly material, whatever happens there. And on the SG&A front, it did step down quarter over quarter, but typically the first quarter is our highest quarter because of payroll taxes and a number of other specific things. So I think we're at a fairly normal level, but over time it will probably move up with the typical cost of living type of increases that you would expect for overhead of our type. Operator: And our next question comes from David Guarino with Green Street. Please go ahead. David Guarino: Hey, thanks. We don't often get to hear about your track record on deals, but I was wondering if you could talk a little bit about some of your recent investments like in Tanzania and the Philippines? How they fare? It would be great just to hear about actual performance in those markets versus your initial underwriting, especially if we kind of consider the capital allocation track record you have as you pursue external growth going forward? Brendan Cavanagh: Yeah, I mean, it's hard to get too specific on all that, but just to touch on the ones that you mentioned, Tanzania, thus far has worked out extremely well. We've had tremendous growth there that we've been very pleased with from an organic leasing standpoint. Obviously, the entry price we came in was attractive and so the return on investment capital thus far has been tremendous in that market. In the case of the Philippines, it was a little bit of a totally different animal. There wasn't an acquisition there. That was almost all brand new builds. And it's really at a fairly early stage. So I'd say that so far it's gone well. The leasing has been strong, but we have a very small portfolio and they're brand new sites. So we've got to give that a little bit more time to see how it plays out. David Guarino: Okay. And then, speaking on the topic on acquisitions, you might have mentioned this in the past, but just to clarify, are you more focused on macro tower assets, or given your experience, you guys have made investments in DAS networks and data centers, is that on the table? And then I guess you kind of carry that over to active equipment. We hear about some of that in Europe, and then some fiber assets as well. Just wondering how far you'd want to stretch out that in macro towers? Brendan Cavanagh: Yeah, I mean, we're a macro tower company, so that's obviously we've spent the vast majority of our time. The other things were specific items that had ancillary strategic rationale that we were looking at, but it's not the core of what we look at. Brendan Cavanagh: Thank you all for joining the call, and we look forward to reporting our results next quarter. Operator: That does conclude our conference for today. Thank you for your participation. You may now disconnect.