Q2/Q3 2024 Earnings: PTC, Entegris, DuPont, and Flowserve Report Strong Results

PTC (PTC) Q3 2024 Earnings Call Transcript | The Motley Fool

Good afternoon, ladies and gentlemen. Thank you for standing by, and welcome to PTC's 2024 third-quarter conference call. During today's presentation, all parties will be in a listen-only mode. Following the presentation, the conference will open for questions. I'd now like to turn the call over to Matt Shimao, PTC's head of investor relations. Please go ahead. Matthew Shimao -- Senior Vice President, Investor Relations Good afternoon. Thank you, Adam, and welcome to PTC's fiscal 2024 third-quarter conference call. On the call today are Neil Barua, chief executive officer; and Kristian Talvitie, chief financial officer. Today's conference call is being broadcast live through an audio webcast, and a replay of the call will be available later today at www.ptc.com. During this call, PTC will make forward-looking statements, including guidance as to future operating results. Because such statements deal with future events, actual results may differ materially from those projected in the forward-looking statements. Additional information concerning factors that could cause actual results to differ materially from those in the forward-looking statements can be found in PTC's annual report on Form 10-K, Form 10-Q, and other filings with the U.S. Securities and Exchange Commission as well as in today's press release. The forward-looking statements, including guidance provided during this call, are valid only as of today's date, July 31, 2024, and PTC assumes no obligation to update these forward-looking statements. During the call, PTC will discuss non-GAAP financial measures. These non-GAAP measures are not prepared in accordance with generally accepted accounting principles. The reconciliation of the non-GAAP financial measures to the most directly comparable GAAP measures can be found in today's press release made available on our website. With that, I'd like to turn the call over to PTC's chief executive officer, Neil Barua. Neil Barua -- Chief Executive Officer Thanks, Matt. In Q3, we again delivered solid constant-currency ARR growth, up 12% year over year, demonstrating that our portfolio of products is resonating with customers. Our Q3 free cash flow growth was also solid, rising 29% year over year. Kristian will take you through our quarterly results and forward-looking guidance in detail. Before we get into more detail, I want to recognize Mike DiTullio, who will transition out of the president and chief operating officer roles at the end of the fiscal year and continue as an advisor to me into 2025. Mike's part in PTC's success has been profound over his tenure of more than 25 years. We certainly wouldn't be the company we are today without him. In addition, he's been a great partner to me as I've stepped into the CEO role. We've been discussing his future plans, and we both agree that it's the right time to start this transition process. When we start fiscal '25, we'll no longer have the COO position within our leadership structure. At this stage of my CEO tenure, my approach is to be close to the business and be more directly involved with operations and execution, especially for our key priorities. Accordingly, I will be assuming many of Mike's responsibilities. Additionally, I'd like to reiterate what I said on last quarter's call, which is that I'm turning over lots of stones and looking at everything in this company in order to usher in a new phase of focus and effectiveness across the entire company. To that end, while Mike's change was externally visible because we filed an 8-K, there are numerous other changes that we have already made and are making across many different areas of the organization. This is an ongoing process that we're doing with the intent of driving more effectiveness in the pursuit of our incredible growth potential. Let's move now to Slide 4, which highlights our product portfolio and strategy. As a reminder, our five focus areas are, one, PLM, which is driven primarily by our Windchill product; two, ALM, which is driven by our Codebeamer product; three, SLM, which is primarily driven by ServiceMax; four, CAD, which is driven primarily by Creo; and five, our continued focus on SaaS. These are the areas where we can create the greatest customer value and are the areas where we are focusing our resources and attention. At the most basic level, our customers need to introduce new products at a faster pace and with higher quality. It is not unusual to hear from customers that they need to shorten their new product introduction timelines in half. That's not possible without digital transformation across their workflows, which is exactly what our products enable. It's also worth highlighting that we are bringing our suite of software offerings together to help product companies improve their competitiveness. Given the unique breadth and openness of our portfolio, we can enable end-to-end Digital Thread initiatives, which leverage a connected flow of product data across design, manufacturing, service, and ultimately, reuse. Our Digital Thread enables product companies to break down silos, streamline workflows, and achieve interoperability across departments, functions, and systems with a single version of truth. It also secures the quality, consistency, and traceability of product-related data, ensuring that the data is up-to-date, accessible, reliable, and actionable. With the digital thread, the right data is delivered to the right people at the right time and in the right context across the value chain. The demand drivers for our core offerings are strong, and our differentiated capabilities to drive Digital Thread initiatives are increasingly important to our customers. There is so much we can do to help our customers drive better business outcomes. To unlock this potential, I have started to focus on our operations, taking a fresh look at ways to continue driving improvements. On last quarter's call, we discussed rebalancing some R&D resources away from creating new stand-alone IoT and augmented reality applications to instead support growth of our core products. That was just the first step. Putting in place an organizational design that enables us to scale more programmatically will set us up for continued success in the future. We are now primarily turning our attention to optimizing our go-to-market and G&A activities. As I mentioned upfront, we've leaned out the go-to-market management structure, so there are less layers between me and our customers. At this point, we are moving forward without the chief operating officer and chief revenue officer roles, and I will be working directly with our head of sales and head of customer success. We are actively looking at every facet of our business to continue driving alignment and effectiveness across our entire company. It is about focus on customer value and getting more effective with each dollar we spend to support them and capture that demand. The opportunities to achieve this are significant here at PTC. We are in the early innings of doing this work, and we expect the heavy lifting to continue in fiscal '25. I'd like to turn now to discuss three of our focus areas to illustrate the significant value we bring to customers. This quarter, I'll touch on what we have been seeing with customers of our Windchill PLM, Codebeamer ALM, and ServiceMax SLM products. Starting with PLM on Slide 5. This is Product Lifecycle Management, and Windchill is our flagship PLM product. PLM systems tend to be really sticky and are mission-critical for our customers. This is software that historically had the function of helping CAD engineers keep track of their CAD files. Now, PLM is at the epicenter of digital transformation initiatives and product companies. As I explained last quarter, product companies are increasingly focused on compressing the time it takes to get new products to market. And at the same time, their products continue to get much more complex, both to design and produce. The complexity becomes untenable, quality and time to market gets impacted. Sooner or later, it becomes very clear that having an advanced PLM system is a strategic necessity. In general manufacturing companies have a long way to go in terms of their digital transformation journeys. And when a product company gets really serious about optimizing and automating their design and manufacturing processes, we tend to see large PLM expansion projects and step function increases in ARR as customers expand their Windchill deployments in terms of both seats and functionality. A good example of this is our Q3 win as a supplier to the automotive industry that specializes in cabling and wiring harness solutions. Given the rise of software-defined vehicles and the importance of electronic wiring systems, the role of this company in the automotive supply chain has grown. It's interesting that this company already appreciated the value of leveraging their PLM system beyond engineering to drive better business outcomes. They are using Windchill within R&D, but they're currently using homegrown tools to drive collaboration across their engineering, supply chain, manufacturing, and quality assurance teams. Over time, maintaining their homegrown system became unsustainable from both the complexity and cost standpoint. They found it compelling that extending Windchill beyond engineering is easy to implement and provides quick time to value, and they decide to standardize on their Windchill system as their backbone for enterprisewide collaboration around their product data. Turning to Slide 6. The second customer example for today is a medical equipment customer that has been using our Creo CAD and Windchill PLM products for years now. What's interesting is that this customer wants to unlock value by going with the Digital Thread approach I highlighted a few minutes ago. Our Codebeamer ALM product helped to complete their Digital Thread vision. After being a Codebeamer customer for about a year testing out the product, they decided they were all-in and ready to move forward with their digital thread initiative. And in Q3, they signed a deal with us that will expand their ARR by 190%. As a reminder, ALM or Application Lifecycle Management helps engineers keep track of product requirements and test to ensure that all requirements are met. This traceability is very important in safety-critical and regulated industries, including the automotive and medical equipment markets, and has been growing in importance across other industries because of the trend toward software-driven products of all types. Products now contain more embedded software than ever. And for many products, there's been an explosion in the number of unique software configurations that need to be developed and updated over time. Codebeamer is a next-gen platform that enables industrial companies to manage this increasing level of complexity. Codebeamer is differentiated from legacy ALM offerings in two key ways. First, Codebeamer has industry-leading traceability capabilities, and second, Codebeamer also helps with time to market by supporting agile development processes. Consider, for example, what happens when a company has a product in the field that fails. Regulators immediately want to understand which version of the software that product had and might even demand that more stringent new requirements be placed on new products the company makes. Codebeamer is becoming the solution of choice to deal with this new reality. Codebeamer is a big part of completing the Digital Thread vision for this customer because software plays such a critical role in their new product innovations. Before having Codebeamer, they faced challenges managing their high volume of software requirements, which led to unnecessary delays in getting new products to market as well as exposure to risk. As a medical equipment company, software innovation and regulatory traceability are front and center for this customer, and the value Codebeamer brought to them gave them the confidence to rely on PTC in a more holistic way. They are expanding their Windchill and Codebeamer deployments and will use Windchill as the foundation for their digital thread. The digital thread is becoming increasingly strategic to customers across many industries, as product companies see the potential to improve their competitiveness by managing the complete life cycle of their products in a more integrated manner. What is most important to thread together can be different for different customers, but having visibility to a more complete picture and being able to gain actionable insights through a Digital Thread of product data is becoming table stakes as the competitive environment continues to intensify across many industries. Turning to our third customer example for today, which is a ServiceMax SLM win on Slide 7. SLM is Service Lifecycle Management and one of our main products here is ServiceMax. The industry leader in field service management for high-value, long-lifecycle products. In Q3, we landed a new PTC customer because of ServiceMax. This customer engineers, manufactures, and services, industrial and electrical power systems around the world, and they like that ServiceMax has become part of PTC. The drivers behind this win were similar in many ways to the elevated company win we highlighted on last quarter's call. The point is that many product companies are not only focused on managing complexity and accelerating time to market, they are also looking for new sources of top-line and bottom-line growth. In this example, the customer had a CEO-led initiative to better leverage their installed base to grow aftermarket revenue in a repeatable and cost-effective manner. Because of organizational silos, the customer currently has fragmented service business operation, which impacts their field service productivity and customer service. They struggle to compete with smaller, local vendors for aftermarket contracts to service their own products. The customer made the strategic decision that it was time to transform their service operations and they selected ServiceMax. The ServiceMax system will be their software foundation and single source of truth for their aftermarket services and customer service initiatives. Before going out into the field, the ServiceMax application will help their service technicians understand everything they need to know about the specific product that needs servicing so that they can bring the right parts with them. The ServiceMax application will also schedule and route the field technicians efficiently and guide the field technicians through complex procedures. As typical of ServiceMax deals, the selection process was very thorough and ServiceMax came on top based on product capabilities that are aligned with the priorities of the customer to drive more proactive customer service, improved visibility into their installed base of products, drive higher aftermarket attach rates and improve field technician utilization. Lastly, we also remain encouraged by our other focus areas that I didn't provide examples for this quarter, which are CAD and SaaS. We have been reinvesting in our business, consistently growing our annual R&D investment footprint to provide greater value to our customers. In Q3, we made incremental progress in each of our five focus areas toward executing in a scalable fashion and focusing our investments on the product advancements that customers care the most about. As I emphasized earlier, you should expect to see a continued focus on aligning all our resources across all operational functions in this company behind our five focus areas. This is foundational work, and we will be disciplined about seeing it through. It will take time and progress may not be linear, but we will leave no stone unturned, as I said, as we focus on scaling our business and further improving the consistency of our execution. With that, I'll hand the call over to Kristian to take you through our Q3 financial results and future guidance. Kristian P. Talvitie -- Executive Vice President, Chief Financial Officer Thank you, Neil, and hello, everyone. Starting off with Slide 9. PTC, again, delivered solid financial results in terms of both ARR and free cash flow in a continued challenging selling environment. As you know, we believe ARR and free cash flow are the most important metrics to assess the performance of our business. To help investors understand our business performance, excluding the impact of foreign exchange volatility, we provide ARR guidance and disclose our ARR results on a constant currency basis. At the end of Q3, our constant-currency ARR was $2.125 billion, up 12% year over year and within our guidance range. Our free cash flow results were also solid, up 29% year over year, while at the same time, continuing to invest in our key focus areas. However, we came in a bit below our guidance of approximately $220 million due to timing. We have a high degree of confidence in our cash flow guidance and targets due to the predictability of our cash collections and the disciplined resource allocation structure we have in place. With the timing issues resolved, we continue to expect free cash flow of $725 million in fiscal '24 and continue to be confident that our business model positions us to deliver solid, predictable results. Turning to Slide 10. Let's look at our ARR growth in more detail. Starting with our product groups. In Q3, we delivered 10% constant-currency ARR growth in CAD and 13% growth in PLM. Despite the overall demand environment, which has been sluggish for a couple of years now, our top line has shown good resilience. Our solid ARR growth is supported by our unique portfolio with a solid footprint in high-growth segments of the market and the digital transformation journeys of our customers. These underlying strengths are further supported by our subscription model, our low churn rate, and the propensity for our customer base to prioritize their own R&D investments through challenging times. Moving to our ARR by region. Our constant currency organic ARR growth was solid across the Americas, Europe, and APAC, with growth in the low- to mid-double digits. Across all regions, our year-over-year organic constant-currency growth rates in Q3 were similar to the growth rates we saw in Q2. Moving to Slide 11. First of all, given the consistency and predictability of our free cash flow, we aim to maintain a low cash balance. As you know, our long-term goal, assuming our debt-to-EBITDA ratio is below three times, remains to return approximately 50% of our free cash flow to shareholders via share repurchases while also taking into consideration the interest rate environment and strategic opportunities. Given the strategic acquisitions, namely ServiceMax and Codebeamer that we've done over the past couple of years and the debt we took on to fund them, we paused our share repurchase program. As we said before, we intend to use substantially all of our free cash flow to pay down our debt in fiscal '24. And as we've been saying, we'll revisit the prioritization of debt pay-down and share repurchases when we get to fiscal '25. We were 2.2 times levered at the end of Q3. During the quarter, we paid down our debt by $195 million and ended Q3 with cash and cash equivalents of $248 million and gross debt of $1.8 billion. We continue to expect that we'll end fiscal '24 with gross debt of approximately $1.7 billion. Lastly, we expect fully diluted shares of approximately $121 million in fiscal '24, up by approximately 1.5 million shares year over year. With that, I'll take you through our guidance on Slide 12. Reflecting our year-to-date performance and our outlook for Q4, we're updating our fiscal '24 constant-currency ARR guidance, lowering the high end of the range by $20 million, and now expect to end the year with constant-currency ARR growth of 11% to 12%. It's worth noting we're updating our revenue guidance accordingly, reducing the high end by $20 million. We're reiterating our free cash flow guidance of approximately $725 million in fiscal '24, given our year-to-date performance and Q4 outlook. For Q4, we're guiding for free cash flow of approximately $83 million and constant-currency ARR of $2.2 billion to $2.22 billion, which corresponds to year-over-year growth of 11% to 12%. We believe we've set our guidance appropriately. I'll get a little more into ARR guidance details on the next slide. But before I do, I'd also like to reiterate my favorite reminder. To help you with your models, we're providing revenue and EPS guidance. But ASC 606 makes revenue and EPS difficult to predict for PTC since we primarily sell on-premise subscriptions. And the way revenue is recognized from these contracts can vary significantly based on variables that aren't necessarily relevant to the performance of the business. I did a teach-in on this subject on our Q4 '22 call that you may want to refer to if you are new to PTC. The summary is we believe ARR and free cash flow rather than revenue and operating income are the best metrics to assess the performance of our business. Importantly, we've maintained consistent billing practices over time. We primarily bill our customers annually upfront one year at a time regardless of contract term lengths. So, our free cash flow results over time are comparable. Moving to Slide 13. Here's an illustrative constant-currency ARR model for Q4. You can see our results over the past 11 quarters and the column on the far right illustrates what is needed to get to the midpoint of our constant-currency ARR guidance. The illustrative model indicates that to hit the midpoint of our Q4 guidance range, we need $85 million of sequential net new ARR growth. This is approximately $10 million more than we added in Q4 of the previous two fiscal years. And this year, we expect to benefit from Codebeamer cross-selling ServiceMax with an aligned and enabled sales force and approximately $5 million more in deferred ARR than we had in Q4 of fiscal '23. We think our guidance range for Q4 and the full year balance both risk and opportunity. And looking out a little further ahead to our fiscal '25, and here, keep in mind that we're still in the middle of our detailed planning process. But I would not be surprised if our official fiscal '25 guidance, when we give it next quarter was in the low double-digit ARR growth range, consistent with our medium-term targets and in line with our performance over the past couple of years, again, balancing both risk and opportunity. I also anticipate our free cash flow guidance would be somewhere within the $825 million to $875 million range we previously communicated. Additionally, as we think about capital allocation, I think you will see us resume share repurchases in fiscal '25 in and around the $300 million level as we balance debt paydown with returning capital to shareholders. Obviously, we'll provide our official guidance on next quarter's call, but we just wanted to provide some directional thinking that we feel pretty comfortable with given the recurring nature of our business model and the budgeting process we have in place. In conclusion, PTC has a strong portfolio, solid strategy, and a great team of people with deep expertise and strong customer relationships. We're focused on disciplined and consistent execution to ensure we deliver on the value-creation opportunities we have ahead of us. With that, I'd like to turn the call over to the operator to begin the Q&A session. Operator Thank you. [Operator instructions] In the interest of time, please limit yourself to one question only. If you have an additional question, please return to the queue. And with that, our first question comes from the line of Siti Panigrahi with Mizuho. Thank you. Thanks for taking my question. Neil, I want to ask about the demand environment. How has that changed over the past quarter? Has it gotten worse or still the same? And when you look at the environment turning around, what do you need to see on the macro data, or which leading indicator you would look at before you start feeling more confident about things turning around? Neil Barua -- Chief Executive Officer Sure. On the first question, in Q3, we saw very small puts and takes across all geographic regions and verticals. Absolutely, no discernible change in any trend there. As we've been saying very consistently, the demand environment in Q3 was consistent with what we've seen over the past couple of years. Good thing, by the way, is our pipeline going to Q4 is strong. In terms of what I'm looking for, what Kristian and I are looking for in terms of areas where we would feel the environment is getting better is how we think about close rates, and consistently for the past few years, close rates have been difficult and challenged. Once those close rates on a growing pipeline become better is my indication of when the environment is better for PTC in terms of securing the deals in a more accelerated manner. But I absolutely feel good about the demand, in fact, our sequential growth and pipeline is increasing and so we're focusing on closing deals and how they actually attribute to in-quarter ARR. Our next question comes from the line of Tyler Radke with Citi. Your line is open. Tyler Radke -- Citi -- Analyst Yeah. Thank you very much for taking the question. You know, I guess on the demand environment, understandably, it's choppy out there. We heard from Microsoft yesterday talking about EMEA weakness. But could you just talk about the trends that you saw play out throughout the quarter? And I know that you're making some go-to-market tweaks as well with taking on more of the customer work, Neil, but how much of this do you think is execution versus macro? And what are you assuming on the environment here in Q4? Thank you. Neil Barua -- Chief Executive Officer Yeah. First of all, I'm actually pleased with the performance that we delivered in Q3. In terms of over the course of the quarter, again, very small puts and takes of any change in trend across geos and verticals. I think we've been focusing and executing quite well in this challenging environment. And again, to be clear, no real change in terms of what we're seeing in terms of customer behavior. And again, maybe different than others on other calls, but I've been very consistent around the environment has been challenged. Even post Q2, we mentioned its challenged, and it remains as such because of this point around close rates. And going into Q4, the way in which we're thinking about this is, and I'll take the piece around guidance. The update to the high end of our guidance takes into account how the deals we landed in Q3 will show up in Q4 ARR. It also factors in the close rates we expect in Q4 based on the further maturation of deals in our pipeline, in our view, how those will impact Q4 in-quarter ARR. So, that guidance range, we feel, is appropriate, balancing up the risk and opportunity from what we see from now to the end of the quarter. Operator Our next question comes from the line of Joe Vruwink with Baird. Your line is open. Joe Vruwink -- Robert W. Baird and Company -- Analyst Great. Thanks for taking my question. Neil, maybe you can expand a bit on what you've observed at PTC and also maybe feedback from customers where ultimately operating a flatter org structure and taking on the roles and responsibilities you outlined at the start, where that makes the most sense and you see an opportunity to actually move results forward. Neil Barua -- Chief Executive Officer Sure. A consistent theme from my prior calls around where are we putting wood behind which arrows. And that is driven by our belief around where we could drive the most customer value and where we have the highest right to win. And so, that's how we set forward the five priorities of the company that I've been consistently talking about for the last couple of quarters. We did some repositioning of product and R&D capabilities in IoT ARR back to core products to reinforce those priorities to deliver a better outcome of those priorities over the next number of years. The same is happening now across all these other functions, in particular, now the focus is around the go-to-market function by which it's not around efficiency, it is around, are we using every person we have in this company effectively toward those five priorities? And so, we're working through making sure whoever is targeting PLM expansion capabilities is adequately enabled, is adequately incented, is structured in our go-to-market model by which they can be successful that delivers value to the customer and returns to the company. And so, that's what we're working through. And the other stones that we're kind of working through is because we've set these priorities very clearly, we're all really energized by these priorities because we're seeing, to your question, a lot of customer demand and pull from it, we're looking at anything we're spending money in that is -- can be better utilized using that same dollar on things that could accelerate those priorities, whether it'd be greater R&D capabilities, which we've been doing it, whether it'd be making sure we position the rest of the organization to serve those customers toward those five priorities. So, that's how we're looking at it currently. And again, much work to do, early innings, and heavy lifting will continue into 2025. Operator Thank you. Our next question comes from the line of Stephen Tusa with JPMorgan. Your line is open. Stephen Tusa -- Analyst Hey, guys, good evening. So, obviously, a lot of different crosscurrents here in the macro, whether it's the kind of budget questions around AI and things like that. Obviously, your key competitor had quite a significant mix. They talked about geopolitics a bit, I guess, you guys aren't seeing that. Can you just remind us of maybe how you differ from Dassault and maybe what makes your model a bit more resilient perhaps? And are you seeing kind of geopolitical issues? Or when you talk about the macro, is it something just a bit more, I guess, financially or business related to customers being a bit more cautious on budgets like we've been hearing for the last year and a half, two years? Neil Barua -- Chief Executive Officer Sure. Good question. Look, from a PTC standpoint, again, I just want to keep reiterating this. We did not see any discernible change in trend, among geographies and verticals. Whatever our competitor mentioned, we didn't really see that same dynamic happen in that vertical at PTC. I'm not sure what we're doing different than them in particular, but we didn't see that dynamic play out here. Partly, we've been very consistent around making sure everyone is clear and the way we're actually operating is within a challenging sales environment. And we've been seeing that and not getting ahead of our skis thinking it's going to change but being -- operating under that environment. And I think that discipline with a great product portfolio, I think, is differentiated across the industry, with a movement toward building the business toward these five priorities that is more consistent to create the execution. Kristian called is why I believe we're continuing to deliver the types of results we are and why Kristian and I are looking at Q4 and making sure with this growing pipeline, we continue to make sure we deliver on the commitments that we're making and drive customer value. Stephen Tusa -- Analyst And then I guess just to follow up -- great answer, first of all, but just the follow-up, looking to next year, obviously, you guys have pretty high confidence in, I guess, giving us a framework for next year in this environment. What would it -- what kind of environment are we talking about to kind of get below to the double-digit range in ARR? And then secondarily, how close are you guys to having the playbook ready to respond on the cash side, like you said, you would be able to in that environment. I don't think we're going to like that type of scenario, but it seems like your model is very defensive from this perspective, it would take a lot to kind of drive it to that point. Just curious what the mindset is around defending the cash at this stage. Yeah, sure. I mean, here, again, I don't think we really want to get into the nitty-gritty details of the guidance for next year. As I said, we're still working through detailed planning process. That said, I think that we've seen our, we'll call it, budgeting process play out here this year. As we've articulated, we started the year with a range of expected outcomes on the top line. We started the year with a spend run rate. And as we progressed through the year, as we get more comfortable, we released more incremental funding into the system. So, that's how we try to gauge it, and we would continue to try to do that, and we're frankly doing it right now, already in preparation for next year and that's how we're thinking about it. So, we're really talking about modulating incremental expense into next year and hopefully not putting ourselves in a situation where we've where we've got to actually pare back expense. I think we feel pretty comfortable about it. As a reminder, please limit yourself to one question only, and if you have an additional question, please return to the queue. Our next question comes from the line of Adam Borg with Stifel. Your line is open. Adam Borg -- Stifel Financial Corp. -- Analyst Awesome. And thanks so much for taking the question. Neil, maybe for you. It's great to hear the continued kind of turning over all the stones as you take a fresh look at the entire organization. How do we think about -- especially so as we think about go-to-market and potential changes there, how do we think about the potential risk of disruptions from those changes in the near term? And how is that contemplated in guidance? Thanks so much. Neil Barua -- Chief Executive Officer Yeah. You know, one of the benefits of having been here now 18 months, maybe a little bit longer, is I've had the time to process, be part of the organization to think through and observe and part of a number of customer conversations, etc., have had a great transition process. Mike DiTullio, as I mentioned, and I feel confident that my thoughtfulness, our thoughtfulness around what to change from a position of strength, not a position of weakness is actually a very exciting thing for many people here at PTC to make sure we're enabling them to be as successful as they can across these five priorities. So, I actually believe that the work we're doing fundamentally is going to be a huge value to a lot of people here at PTC to unleash even greater work that they've been doing. And so, to that end, these are going to be very intentional moves. I've done it a number of times in my career, and it's to drive more effectiveness. And I feel really good about our ability to manage through these changes. Adam Borg -- Stifel Financial Corp. -- Analyst That's awesome. And maybe just a quick housekeeping for Kristian. I know we lowered the top end of the ARR range by $20 million, and I apologize if I missed this. I think last quarter, it was lower due to some ARR contracts being renegotiated or more deferred ARR. Is that what we're talking about here? Or is there something different? And I apologize if I missed this. Thanks again. Kristian P. Talvitie -- Executive Vice President, Chief Financial Officer Yeah. No, there were no other changes to the deferred ARR, like we talked about last quarter. This was simply reflecting, and this is I think what Neil was saying earlier, reflecting how our Q3 results came in and the composition of those deals, and how they roll into ARR in Q3 and Q4 and beyond. And the outlook to the best of our ability for Q4 as well, given the deals that are in play in the pipeline and expectations around what the composition of those deals is going to look like as they materialize into ARR. Operator Our next question comes from the line of Joshua Tilton with Wolfe Research. Your line is open. Joshua Tilton -- Wolfe Research -- Analyst Hey, guys. I actually want to follow up on that last question. I want to ask it a little differently. Kristian, I always appreciate your accounting teach-in, and one of the things you emphasize is the relationship between ARR and free cash flow. And I guess if I look, free cash flow missed by $10 million in the quarter, and you're also lowering the midpoint of the full-year ARR number by $10 million as well, kind of implies that there was a $10 million deal or $10 million of ARR that should have landed this quarter and is no longer in the guidance. I guess, is that the right read. And if so, is that because the deal is going to close in later periods? Or is this just you guys being prudent? Any color there would be great. Kristian P. Talvitie -- Executive Vice President, Chief Financial Officer Yeah, sure. It's a great question, Josh. No. And that actually is not the case at all. On free cash flow is actually simply timing. I mean, here, just being completely candid, we had a bunch of collections that were due in the last two days of the quarter, the last two days of the quarter happened to be a Saturday and Sunday. We were hopeful that we were going to get that cash in on Friday or before, but obviously, customers have a contractual right to actually pay it the following week. And so, that's what happened on the cash flow. We were hopeful that we were going to get it on the week before. We've now got that cash. So, hence, there's no change to the cash flow forecast for the year. That's the timing issue. Joshua Tilton -- Wolfe Research -- Analyst Super helpful. And just to confirm, also more of a clarification, I think as heading into the second half, you guys still had $10 million more in deferred ARR in the balance this year versus last year. Is all $10 million of that remaining with some of that recognized this quarter? Can you just help us understand that? Kristian P. Talvitie -- Executive Vice President, Chief Financial Officer Yeah. It was about half of it in last quarter and half of it this quarter. Sorry, let me -- half of it -- I'll be more precise. Half of it in Q3 and about half of it in Q4. Our next question comes from the line of Saket Kalia with Barclays. Your line is open. Saket Kalia -- Barclays -- Analyst OK, great. Hey, Neil. Hey, Kristian. Thanks for taking my question here. Neil, maybe for you. It feels like close rates is one of if not maybe the major reason here for just the revised ARR guide. And so, the question is, can we maybe talk about that metric anecdotally, of course, for ServiceMax and Codebeamer cross-sell? I mean, I know the team really enabled PTC sellers to go after those opportunities this year. How has that sort of trended? And how are you feeling about those businesses when you think about close rates? Neil Barua -- Chief Executive Officer Yeah. Let me make a piece of this clear around close rates. Our assumption going into Q4 about close rates and looking at a deal-by-deal maturation of the pipeline is no different than our view of close rates that have been evident for the most part in general for the last few years. The dynamic of what we're doing on Q4 right now in terms of guidance, how we think about it is we now know what happened in Q3. We now know the composition, meaning how the deals that we closed in Q3 are going to actually go into ARR, whether they all came into Q3 or whether part of it goes into Q4 ARR or part of it goes into the next subsequent years. So, now, we have that data point. We have now made the assessment around all the deals that are maturing in the pipeline and the close rates is consistent with what we've seen in prior quarters and years. So, it's a continued challenge on the close rate, not worse, not better. And we've made assumptions around how that ARR when it closes, actually comes into ARR. And that's the area where the precision is difficult for the company, given is it going to be a deal that ramps over time. Is it all going to come into one quarter? And looking at all those factors, we determined the guidance range that we put with the risk and opportunities balanced. In terms of Codebeamer and ServiceMax, Saket, what I will say anecdotally is, we are continuing to be pleased, excited about the buildup and momentum of Codebeamer and the interest and reception we're getting from the market, the reception that we're getting from customers that are testing out like the example that I gave to you that are thinking about broadening the expansion of the utilization across the company Codebeamer. And on ServiceMax, the business is starting to work in terms of continued buildup of really good pipeline as well as close that happened for the last year to date through Q3 and quite a lot of very interesting deals that we're assuming will close in Q4 to allow for a really strong jump off into next year that we will make sure we continue. So, on both fronts, all systems go, and we're very pleased so far with the momentum we still have to close and continue that momentum to sustain over the next number of years. Our next question comes from the line of Jason Celino with KeyBanc Capital Markets. Your line is open. Jason Celino -- KeyBanc Capital Markets -- Analyst Hey, thanks for fitting me in. How are you baking in -- well, let me rephrase. Your customers decision-making, whether it's close rates or pipeline or whether they want to expand, how are they baking in the U.S. election into that process? I mean, you serve some industries like automotive and aerospace and defense that are sensitive to that. And then how are you baking that into the guidance framework, if at all? Thank you. Neil Barua -- Chief Executive Officer Yeah. Hey, Jason. It's the first time in my career where I've been spending so much time with executives that at customers and across the world, and they ask me who's going to win the election in the U.S. It's a consistent and quite a confusing time for everyone around what happens in the U.S. That being said, I think, for the most part, customers are understanding that whoever gets put in the office, a lot of things don't dramatically change depending on the composition of what happens across all different constituents of the U.S. election. And so, part of what we're seeing and part of what we're continuing to assume and hearing most importantly from our customers is we got to get on with digital transformation, regardless of if this person's an office or that person's office because we are not becoming competitive if we can deliver products faster with better quality and a more sustainable cost structure, given all the things that are happening around the world. I will say that geopolitics, the environment, the uncertainty, wars have been consistent for the last number of years, which is why we continue to say we've not said that the environment is getting better. We don't believe it's getting worse based on this, and we're going to navigate through this time period, and we've thought through that in the way in which we set the guidance here. Our next question comes from the line of Matthew Hedberg with RBC Capital Markets. Your line is open. Mike Richards -- RBC Capital Markets -- Analyst Hey, guys. It's Mike Richards on for Matt. So, I appreciate the early look into 2025. So, maybe how should we be thinking about the drivers of that low double-digit growth and how that sort of evolves from this year as it pertains to the five focus areas and, even acknowledging that it's a decade-long journey for SaaS, maybe how that might contribute more to growth as we move forward? Thanks. Neil Barua -- Chief Executive Officer Yeah. Again, I mean, I think we'll get into providing more details when we give the official fiscal '25 guidance next quarter. Operator Our next question comes from the line of Jay Vleeschhouwer with Griffin Securities. Jay Vleeschhouwer -- Analyst Thank you. Good evening. Neil, Kristian, one of our observations about your largest market, historically, I mean, with the CAD market is that over the last year, the share shifting that we had seen in the prior few years which worked out to your benefit has somewhat abated. In other words, share seems much more stable of late in that market. If it should turn out that the CAD market becomes increasingly competitive, how do you think about your competitive responses, perhaps on pricing or packaging or some other means? And again, if it were to become more competitive, how might that affect your broader cross-selling initiatives or ability to close cross-selling? And then secondarily, Neil, I like your comments on the internal stone turning. Could you elaborate on the R&D changes that you're making, particularly in terms of the common platform that you've been working on, namely Atlas, which we frankly have not heard a good deal about lately? Thank you. Neil Barua -- Chief Executive Officer Sure. You know, on the first part, on CAD, we have two awesome ways in which we're addressing the market. As you know, Jay, we've got Onshape, the industry's only cloud-native CAD application, and we got Creo, which is awesome, as you know. And so, those two together, we feel have competitiveness. I'm not talking about Onshape. It's a great part of our business, building momentum. We feel very good about our competitive positioning. It's starting to scale. I will talk about it when it has a meaningful impact at an aggregate level to the financials of the business. But strategically, we continue to make sure our chips are being placed to ensure that Onshape is successful against some of the other solutions that are out there from our competitors. And then you got Creo, which is a very strong tool. And our belief is the connection of Creo to Windchill and ultimately, Codebeamer, the three together is a very strong value proposition for many customers thinking about how they think about the Digital Thread. So, Jay, I would say on the CAD business, we're ready, we're competing, we're in several different dynamics of deals that might cause share shifts, might not. As you know, it's not an easy business to do share shifts, but we believe we have a very comprehensive offering on both fronts industry-leading scale player in Creo and Onshape, which is starting to hit their stride here, and we're going to continue to focus in on it. On your point around turning over stones on R&D, what I'll say is, we're focusing in, particularly on go-to-market and G&A, we're making sure on R&D, we are focused in on making sure the team is aligned to deliver on the road map. Every single one of our customers, Jay, is saying, "We love your products. We love where you're going in terms of building, feature functionality, scalability of those products. Just do it." And so, job No. 1 for the R&D team is keep doing that and do it with precision, energy because our customers need it. So, that's number one, including, by the way, the Atlas team because that is a fundamental layer by which we have the ability to offer our SaaS offerings. And two, continue to build innovative offerings. We're continuing to build ways in which we could add generative AI into our products. We're continuing to do -- we just released an awesome integration of ServiceMax to Windchill on time with great quality on July 11 of this month. We have another release of a ServiceMax ability to now have ServiceMax able to be sold alongside Windchill in the federal space. So, we're continuing to build some of these innovations, including with Codebeamer, Windchill and Creo and Onshape, to make sure we're at the best-in-class here. I'll pause there. Our next question comes from the line of Clarke Jeffries with Piper Sandler. Your line is open. Clarke Jeffries -- Piper Sandler -- Analyst Hello. Thank you for taking the question. I wanted to ask Kristian, we're asking a lot of questions here about close rates and pipeline, but maybe going back to that framework that you've said around ARR and what you need to believe on a sequential ARR basis. I just wanted to maybe have the discussion on -- in relation to that $85 million for Q4, you called out the $5 million related to some of those existing contracts. What is the percentage in that $85 million that's going to come from uplift or pricing drivers that are relatively in hand versus new sales or upsells that might be more sensitive to execution? Thank you. Kristian P. Talvitie -- Executive Vice President, Chief Financial Officer Yes, sure. So, I guess we could take a stab at it. And I think I would think about it in a few different buckets. There is some benefit from pricing. As you know, we tend to be pretty customer-friendly on that front, but there's certainly some benefit from that. I would say, consistent with what's been in the past couple of years. Then I would probably start moving up the stack and thinking about the channel. The channel has been a pretty consistent pro forma, really for a number of years now, and we haven't really seen any meaningful changes in one direction or the other. That would indicate a change in the trend there. So, that gives us some level of comfort. Then I would move up also more into our kind of base business and base transactions. And again, the kind of volumes that we've seen there have been pretty consistent. And then lastly, you get to the large deals, and that's really where the volatility is in any given quarter. And of course, it's also those large deals where you see the other dynamics come into play, not only is it going to close in the quarter, but if it closes, how much of it's in quarter start? Is it a ramp deal? Is it all starting in the quarter, etc.? And that's the part that's on a quarter-by-quarter basis, difficult to predict with a high degree of certainty. Thank you. I will now hand the call back over to Neil Barua for closing remarks. Neil Barua -- Chief Executive Officer Thank you, everyone, for joining us today. Here's what's ahead specific to investor conferences: August 20, Steve Dertien, our CTO, will join the Rosenblatt Virtual Tech Summit Conference; September 4, Kristian will be at the Citi Global Tech Conference in New York. On behalf of the team, thank you again, and we look forward to engaging with you.

PTC Inc. (PTC) Q3 2024 Earnings Call Transcript

Matt Shimao - Head of Investor Relations Neil Barua - Chief Executive Officer Kristian Talvitie - Executive Vice President and Chief Financial Officer Good afternoon, ladies and gentlemen. Thank you for standing by, and welcome to PTC's 2024 Third Quarter Conference Call. During today's presentation, all parties will be in a listen-only mode. Following the presentation, the conference will be open for questions. I would now like to turn the call over to Matt Shimao, PTC's Head of Investor Relations. Please go ahead. Matt Shimao Good afternoon. Thank you, Adam, and welcome to PTC's fiscal 2024 third quarter conference call. On the call today are Neil Barua, Chief Executive Officer, and Kristian Talvitie, Chief Financial Officer. Today's conference call is being broadcast live through an audio webcast and a replay of the call will be available later today at www.ptc.com. During this call, PTC will make forward-looking statements, including guidance as to future operating results. Because such statements deal with future events, actual results may differ materially from those projected in the forward-looking statements. Additional information concerning factors that could cause actual results to differ materially from those in the forward-looking statements can be found in PTC's annual report on Form 10-K, Form 10-Q, and other filings with the US Securities and Exchange Commission, as well as in today's press release. The forward-looking statements, including guidance provided during this call, are valid only as of today's date, July 31, 2024, and PTC assumes no obligation to update these forward-looking statements. During the call, PTC will discuss non-GAAP financial measures. These non-GAAP measures are not prepared in accordance with the Generally Accepted Accounting Principles. A reconciliation of the non-GAAP financial measures to the most directly comparable GAAP measures can be found in today's press release made available on our website. With that, I'd like to turn the call over to PTC's Chief Executive Officer, Neil Barua. Neil Barua Thanks, Matt. In Q3, we again delivered solid constant currency ARR growth, up 12% year-over-year, demonstrating that our portfolio products is resonating with customers. Our Q3 free cash flow growth was also solid, rising 29% year-over-year. Kristian will take you through our quarterly results and forward-looking guidance in detail. Before we get into more detail, I want to recognize Mike DiTullio, who will transition out of the President and Chief Operating Officer roles at the end of the fiscal year and continue as an advisor to me into 2025. Mike's part in PTC success has been profound over his tenure of more than 25 years. We certainly wouldn't be the company we are today without him. In addition, he's been a great partner to me as I've stepped into the CEO role. We've been discussing his future plans and we both agree that it's the right time to start this transition process. When we start fiscal 2025, we'll no longer have the COO position within our leadership structure. At this stage of my CEO tenure, my approach is to be close to the business and be more directly involved with operations and execution, especially for our key priorities. Accordingly, I will be assuming many of Mike's responsibilities. Additionally, I'd like to reiterate what I said on last quarter's call, which is that I'm turning over lots of stones and looking at everything in this company in order to usher in a new phase of focus and effectiveness across the entire company. To that end, while Mike's change was externally visible because we filed an 8-K, there are numerous other changes that we have already made and are making across many different areas of the organization. This is an ongoing process that we're doing with the intent of driving more effectiveness in the pursuit of our incredible growth potential. Let's move down to slide 4, which highlights our product portfolio and strategy. As a reminder, our five focus areas are, one, PLM, which is driven primarily by our Windchill product; two, ALM, which is driven by our Codebeamer product; three, SLM, which is primarily driven by ServiceMax; four, CAD, which is driven primarily by Creo; and five, our continued focus on SaaS. These are the areas where we can create the greatest customer value and are the areas where we are focusing our resources and attention. At the most basic level, our customers need to introduce new products at a faster pace and with higher quality. It is not unusual to hear from customers that they need to shorten their new product introduction timelines in half. That's not possible without digital transformation across their workflows, which is exactly what our products enable. It's also worth highlighting that we are bringing our suite of software offerings together to help product companies improve their competitiveness. Given the unique breadth and openness of our portfolio, we can enable end-to-end digital threat initiatives, which leverage a connected flow of product data across design, manufacturing, service, and ultimately reuse. A digital thread enables product companies to break down silos, streamline workflows, and achieve interoperability across departments, functions, and systems, a single version of truth. It also secures the quality, consistency, and traceability of product-related data, ensuring that the data is up-to-date, accessible, reliable, and actionable. With a digital thread, the right data is delivered to the right people at the right time and in the right context across the value chain. The demand drivers for our core offerings are strong and our differentiated capabilities to drive digital thread initiatives are increasingly important to our customers. There is so much we can do to help our customers drive better business outcomes. To unlock this potential, I have started to focus on our operations, taking a fresh look at ways to continue driving improvements. On last quarter's call, we discussed rebalancing some R&D resources away from creating new standalone IoT and augmented reality applications to instead support growth of our core products. That was just the first step, putting in place an organizational design that enables us to scale more programmatically will set us up for continued success in the future. We are now primarily turning our attention to optimizing our go-to-market and G&A activities. As I mentioned upfront, we've leaned out the go-to-market management structure, so there are less layers between me and our customers. At this point, we are moving forward without the chief operating officer and chief revenue officer roles, and I will be working directly with our Head of Sales and Head of Customer Success. We are actively looking at every facet of our business to continue driving alignment and effectiveness across our entire company. It is about focusing on customer value and getting more effective with each dollar we spend to support them and capture that demand. The opportunities to achieve this are significant here at PTC. We are in the early innings of doing this work and we expect the heavy lifting to continue in fiscal 2025. I'd like to turn now to discuss three of our focus areas to illustrate the significant value we bring to customers. This quarter, I'll touch on what we have been seeing with customers of our Windchill PLM, Codebeamer ALM, and ServiceMax SLM products. Starting with PLM on slide 5, this is product lifecycle management, and Windchill is our flagship PLM product. PLM systems tend to be really sticky and are mission critical for our customers. This is software that historically had the function of helping CAD engineers keep track of their CAD files. Now PLM is at the epicenter of digital transformation initiatives at product companies. As I explained last quarter, product companies are increasingly focused on compressing the time it takes to get new products to market. And at the same time, their products continue to get much more complex, both to design and produce. The complexity becomes untenable. Quality and time to market gets impacted. Sooner or later, it becomes very clear that having an advanced PLM system is a strategic necessity. In general, manufacturing companies have a long way to go in terms of their digital transformation journeys. And when a product company gets really serious about optimizing and automating their design and manufacturing processes, we tend to see large PLM expansion projects and step function increases in ARR as customers expand their Windchill deployments in terms of both seats and functionality. A good example of this is our Q3 win at a supplier to the automotive industry that specializes in cabling and wiring harness solutions. Given the rise of software-defined vehicles and the importance of electronic wiring systems, the role of this company in the automotive supply chain has grown. It's interesting that this company already appreciated the value of leveraging their PLM system beyond engineering to drive better business outcomes. They are using Windchill within R&D, but they're currently using homegrown tools to drive collaboration across their engineering, supply chain, manufacturing, and quality assurance teams. Over time, maintaining their homegrown system became unsustainable from both a complexity and cost standpoint. They found it compelling that extending Windchill beyond engineering is easy to implement and provides quick time to value, and they decided to standardize on their Windchill system as their backbone for enterprise-wide collaboration around their product data. Turning to slide 6, the second customer example for today is a medical equipment customer that has been using our Creo CAD and Windchill PLM products for years now. What's interesting is that this customer wants to unlock value by going with the digital thread approach I highlighted a few minutes ago. Our Codebeamer ALM product helped to complete their digital thread vision. After being a Codebeamer customer for about a year testing out the product, they decided they were all in and ready to move forward with their digital thread initiative, and in Q3, they signed a deal with us that will expand their ARR by 190%. As a reminder, ALM, or Application Lifecycle Management, helps engineers keep track of product requirements and tests to ensure that all requirements are met. This traceability is very important in safety-critical and regulated industries, including the automotive and medical equipment markets, and is growing in importance across other industries because of the trend towards software-driven products of all types. Products now contain more embedded software than ever, and for many products, there's been an explosion in the number of unique software configurations that need to be developed and updated over time. Codebeamer is a next-gen platform that enables industrial companies to manage this increasing level of complexity. Codebeamer is differentiated from legacy ALM offerings in two key ways. First, Codebeamer has industry-leading traceability capabilities, and second, Codebeamer also helps with time to market by supporting Agile development processes. Consider, for example, what happens when a company has a product in the field that fails? Regulators immediately want to understand which version of the software that product had, and might even demand that more stringent new requirements be placed on new products the company makes. Codebeamer is becoming the solution of choice to deal with this new reality. Codebeamer is a big part of completing the digital thread vision for this customer because software plays such a critical role in their new product innovations. Before having Codebeamer, they face challenges managing their high volume of software requirements, which led to unnecessary delays in getting new products to market as well as exposure to risk. As a medical equipment company, software innovation and regulatory traceability are front and center for this customer and the value Codebeamer brought to them gave them the confidence to rely on PTC in a more holistic way. They are expanding their Windchill and Codebeamer deployments and will use Windchill as the foundation for their digital thread. The digital thread is becoming increasingly strategic to customers across many industries as product companies see the potential to improve their competitiveness by managing the complete lifecycle of their products in a more integrated manner. What is most important to thread together can be different for different customers. But having visibility to a more complete picture and being able to gain actionable insights through a digital thread of product data is becoming table stakes as the competitive environment continues to intensify across many industries. Turning to the third customer example for today, which is a ServiceMax SLM win on slide 7. SLM is Service Lifecycle Management and one of our main products here is ServiceMax, the industry leader in field service management for high value, long lifecycle products. In Q3, we landed a new PTC customer because of ServiceMax. This customer engineers, manufacturers and services industrial and electrical power systems around the world and they like that ServiceMax has become part of PTC. The drivers behind this win were similar in many ways to the elevator company when we highlighted on last quarter's call. The point is that many product companies are not only focused on managing complexity and accelerating time to market, they are also looking for new sources of top line and bottom line growth. In this example, the customer had a CEO led initiative to better leverage their install base to grow aftermarket revenue in a repeatable and cost-effective manner. Because of organizational silos, the customer currently has fragmented service business operation, which impacts their field service productivity and customer service. They struggle to compete with smaller local vendors for aftermarket contracts to service their own products. The customer made the strategic decision that it was time to transform their service operations and they selected ServiceMax. The ServiceMax system will be their software foundation and single source of truth for their aftermarket services and customer service initiatives. Before going out into the field, the ServiceMax application will help their service technicians understand everything they need to know about the specific product that needs servicing, so that they can bring the right parts with them. The ServiceMax application will also schedule and route the field technicians efficiently and guide the field technicians through complex procedures. As typical of ServiceMax deals, the selection process was very thorough and ServiceMax came on top based on product capabilities they're aligned with the priorities of the customer to drive more proactive customer service, improve visibility into their install base of products, drive higher aftermarket attach rates and improve field technician utilization. Lastly, we also remain encouraged by our other focus areas that they didn't provide examples for this quarter, which are CAD and SaaS. We have been reinvesting in our business, consistently growing our annual R&D investment footprint to provide greater value to our customers. In Q3, we made incremental progress in each of our five focus areas towards executing in a scalable fashion and focusing our investments on the product advancements that customers care the most about. As I emphasized earlier, you should expect to see a continued focus on aligning all our resources across all operational functions in this company behind our five focus areas. This is foundational work and we will be disciplined about seeing it through. It will take time and progress may not be linear, but we will leave no stone unturned, as I said, as we focus on scaling our business and further improving the consistency of our execution With that, I'll hand the call over to Kristian to take you through our Q3 financial results and future guidance. Kristian Talvitie Thank you, Neil. And hello, everyone. Starting off with slide 9, PTC again delivered solid financial results in terms of both ARR and free cash flow in a continued challenging selling environment. As you know, we believe ARR and free cash flow are the most important metrics to assess the performance of our business. To help investors understand our business performance, excluding the impact of foreign exchange volatility, we provide ARR guidance and disclose our ARR results on a constant currency basis. At the end of Q3, our constant currency ARR was $2.125 billion, up 12% year-over-year and within our guidance range. Our free cash flow results were also solid, up 29% year-over-year, while at the same time continuing to invest in our key focus areas. However, we came in a bit below our guidance of approximately $220 million due to timing. We have a high degree of confidence in our cash flow guidance and targets due to the predictability of our cash collections and the disciplined resource allocation structure we have in place. With the timing issues resolved, we continue to expect free cash flow of $725 million in fiscal 2024 million and continue to be confident that our business model positions us to deliver solid, predictable results. Turning to slide 10, let's look at our ARR growth in more detail. Starting with our product groups, in Q3, we delivered 10% constant currency ARR growth in CAD and 13% growth in PLM. Despite the overall demand environment, which has been sluggish for a couple of years now, our top line has shown good resilience. Our solid ARR growth is supported by our unique portfolio with a solid footprint in high growth segments of the market and the digital transformation journeys of our customers. These underlying strengths are further supported by our subscription model, our low churn rate and the propensity for our customer base to prioritize their own R&D investments through challenging times. Moving to our ARR by region, our constant currency organic ARR growth was solid across the Americas, Europe and APAC, with growth in the low to mid-double-digits. Across all regions, our year-over-year organic constant currency growth rates in Q3 were similar to the growth rates we saw in Q2. Moving to slide 11. First of all, given the consistency and predictability of our free cash flow, we aim to maintain a low cash balance. As you know, our long term goal, assuming our debt to EBITDA ratio is below 3 times, remains to return approximately 50% of our free cash flow to shareholders via share repurchases while also taking into consideration the interest rate environment and strategic opportunities. Given the strategic acquisitions, namely ServiceMax and Codebeamer that we've done over the past couple of years and the debt we took on to fund them, we've paused our share repurchase program. As we said before, we intend to use substantially all of our free cash flow to pay down our debt in fiscal 2024. And as we've been saying, we'll revisit the prioritization of paydown and share repurchases when we get to fiscal 2025. We were 2.2 times levered at the end of Q3. During the quarter, we paid down our debt by $195 million and ended Q3 with cash and cash equivalents of $248 million and gross debt of $1.8 billion. We continue to expect that we'll end fiscal 2024 with gross debt of approximately $1.7 billion. Lastly, we expect fully diluted shares are approximately 121 million in fiscal 2024, up by approximately 1.5 million shares year-over-year. With that, I'll take you through our guidance on slide 12. Reflecting our year-to-date performance and our outlook for Q4, we're updating our fiscal 2024 constant currency ARR guidance, lowering the high end of the range by $20 million and now expect to end the year with constant currency ARR growth of 11% to 12%. It's worth noting we're updating our revenue guidance accordingly, reducing the high end by $20 million. We're reiterating our free cash flow guidance of approximately $725 million in fiscal 2024, given our year-to-date performance and Q4 outlook. For Q4, we're guiding for free cash flow of approximately $83 million and constant currency ARR of $2.2 billion to $2.22 billion, which corresponds to year-over-year growth of 11% to 12%. We believe we've set our guidance appropriately. I'll get a little more into ARR guidance details on the next slide. But before I do, I'd also like to reiterate my favorite reminder. To help you with your models, we're providing revenue and EPS guidance, but ASC 606 makes revenue and EPS difficult to predict for PTC since we primarily sell on-premises subscriptions. And the way revenue is recognized from these contracts can vary significantly based on variables that aren't necessarily relevant to the performance of the business. I did a teach-in on this subject on our Q4 2022 call that you may want to refer to if you are new to PTC. The summary is we believe ARR and free cash flow, rather than revenue and operating income, are the best metrics to assess the performance of our business. Importantly, we've maintained consistent billing practices over time. We primarily bill our customers annually upfront one year at a time regardless of contract term lengths, so our free cash flow results over time are comparable. Moving to slide 13, here's an illustrative constant currency ARR model for Q4. You can see our results over the past 11 quarters and the column on the far right illustrates what is needed to get to the midpoint of our constant currency ARR guidance. The illustrative model indicates that, to hit the midpoint of our Q4 guidance range, we need $85 million of sequential net new ARR growth. This is approximately $10 million more than we added in Q4 of the previous two fiscal years. And this year, we expect to benefit from Codebeamer cross-selling ServiceMax with an aligned and enabled sales force and approximately $5 million more deferred ARR than we had in Q4 of fiscal 2023. We think our guidance range for Q4 and the full year balance both risk and opportunity. And looking out a little further ahead to our fiscal 2025. And here, keep in mind that we're still in the middle of our detailed planning process. But I would not be surprised if our official fiscal 2025 guidance, when we give it next quarter, was in the low double-digit ARR growth range, consistent with our medium-term targets and in line with our performance over the past couple of years. Again, balancing both risk and opportunity. I also anticipate our free cash flow guidance would be somewhere within the $825 million to $875 million dollar range we previously communicated. Additionally, as we think about capital allocation, I think you will see us resume share repurchases in fiscal 2025 in and around the $300 million level as we balance debt pay down with returning capital to shareholders. Obviously, we'll provide our official guidance on next quarter's call, but we just wanted to provide some directional thinking that we feel pretty comfortable with, given the recurring nature of our business model and the budgeting process we have in place. In conclusion, PTC has a strong portfolio, solid strategy, and a great team of people with deep expertise and strong customer relationships. We're focused on disciplined and consistent execution to ensure we deliver on the value creation opportunities we have ahead of us. With that, I'd like to turn the call over to the operator to begin the Q&A session. [Operator Instructions]. And with that, our first question comes from the line of Siti Panigrahi with Mizuho. Siti Panigrahi Neil, I want to ask about the demand environment. How has that changed over the past quarter? Has it gotten worse or still the same? And when you look at the environment turning around, what do you need to see on the macro data or which leading indicator you'd look at before you start feeling more confident about things turning around? Neil Barua On the first question, in Q3, we saw very small puts and takes across all geographic regions and verticals. Absolutely no discernible change in any trend there. As we've been saying very consistently, the demand environment in Q3 was consistent with what we've seen over the past couple of years. Good thing, by the way, is our pipeline going to Q4 is strong. In terms of what I'm looking for, what Kristian and I are looking for in terms of areas where we would feel the environment's getting better, is how we think about close rates. And consistently, for the past few years, close rates have been difficult and challenged. Once those close rates on a growing pipeline become better, it is my indication of when the environment is better for PTC in terms of securing the deals in a more accelerated manner. But I absolutely feel good about the demand. In fact, our sequential growth and pipeline is increasing, and so we're focusing on closing deals and how they actually attribute to in-quarter ARR. Our next question comes from the line of Tyler Radke with Citi. Tyler Radke I guess on the demand environment, understandably it's choppy out there. We heard from Microsoft yesterday talking about EMEA weakness. But could you just talk about the trends that you saw play out throughout the quarter? And I know that you're making some go-to-market tweaks as well with taking on more of the customer work, Neil. But how much of this do you think is kind of execution versus macro? And what are you kind of assuming on the environment here in Q4? Neil Barua First of all, I'm actually pleased with the performance that we delivered in Q3. In terms of over the course of the quarter, again, very small puts and takes of any change in trend across geos and verticals. I think we've been focusing and executing quite well in this challenging environment. And again, to be clear, no real change in terms of what we're seeing in terms of customer behavior. And again, maybe different than others on other calls, but I've been very consistent around the environment has been challenged. Even post Q2, we mentioned its challenged and it remains as such because of this point around close rates. And going into Q4, the way in which we're thinking about this is, and I'll take the piece around guidance, the update to the high end of our guidance takes into account how the deals we landed in Q3 will show up in Q4 ARR. It also factors in the close rates we expect in Q4 based on the further maturation of deals in our pipeline. In our view, how those will impact Q4 in-quarter ARR. So that guidance range we feel is appropriate, balancing up the risks and opportunity from what we see from now to the end of the quarter. Our next question comes from the line of Joe Vruwink with Baird. Joe Vruwink Neil, maybe you can expand a bit on what you've observed at PTC and also maybe feedback from customers where ultimately operating a flat org structure and taking on the roles and responsibilities you outlined at the start where that makes the most sense and you see an opportunity to actually move results forward. Neil Barua A consistent theme from my prior calls around where are we putting wood behind which arrows and that is driven by our belief around where we could drive the most customer value and where we have the highest right to win. And so, that's how we set forward the five priorities of the company that I've been consistently talking about for the last couple of quarters. We did some repositioning of product and R&D capabilities in IoT ARR back to core products to reinforce those priorities to deliver a better outcome of those priorities over the next number of years. The same is happening now across all these other functions. In particular now, the focus is around the go-to-market function, by which it's not around efficiency. It is around are we using every person we have in this company effectively towards those five priorities. And so, we're working through making sure whoever is targeting PLM expansion capabilities is adequately enabled, is adequately incented, is structured in our go-to-market model by which they can be successful that delivers value to the customer and returns to the company. And so, that's what we're working through. And the other stones that we're kind of working through is because we've set these priorities very clearly, we're all really energized by these priorities because we're seeing, to your question, a lot of customer demand and pull from it. We're looking at anything we're spending money in that can be better utilized using that same dollar on things that could accelerate those priorities, whether it be greater R&D capabilities, which we've been doing it, whether it be making sure we position the rest of your organization to serve those customers towards those five priorities. So that's how we're looking at it currently. And again, much work to do, early innings and heavy lifting will continue into 2025. Our next question comes from the line of Stephen Tusa with J.P. Morgan. Stephen Tusa Obviously, a lot of different cross currents here in the macro, whether it's the kind of budget questions around AI and things like that. Obviously, your key competitor had quite a significant miss. They talked about geopolitics a bit. I guess you guys aren't seeing that. Can you just remind us of maybe how you differ from Dassault [ph] and maybe what makes your model a bit more resilient perhaps? And are you seeing kind of geopolitical issues? Or when you talk about the macro, is it something just a bit more, I guess, financially or business related to customers being a bit more cautious on budgets like we've been hearing for the last year-and-a-half, two years? Neil Barua Look, from a PTC standpoint, again, I just want to keep reiterating this. We did not see any discernible change in trend amongst geographies and verticals. Whatever our competitor mentioned, we didn't really see that same dynamic happen in that vertical at PTC. I'm not sure what we're doing different than them, in particular, but we didn't see that dynamic play out here. Partly, we've been very consistent around making sure everyone's clear in the way we're actually operating is within a challenging sales environment. And we've been seeing that and not getting ahead of our skis thinking it's going to change, but being operating under that environment. And I think that discipline with a great product portfolio, I think, is differentiated across the industry with a movement towards building the business towards these five priorities that is more consistent to create the execution. Kristian called, is why I believe we're continuing to deliver the types of results we are and why Kristian and I are looking at Q4 and making sure with this growing pipeline, we continue to make sure we deliver on the commitments that we're making and drive customer value. Stephen Tusa I guess just a follow-up, great answer first of all, but just the follow-up. Looking at next year, obviously, you guys have pretty high confidence in, I guess, giving us a framework for next year in this environment. What kind of environment are we talking about to get below the double digit range in ARR? Secondarily, how close are you guys to having the playbook ready to respond on the cash side? Like you said, you would be able to in that environment. I don't think we're going to that type of scenario, but it seems like your model is very defensive from this perspective. It would take a lot to drive you to that point. Just curious what the mindset is around defending the cash at this stage. Again, I don't think we really want to get into the nitty gritty details of the guidance for next year. As I said, we're still working through the detailed planning process. That said, I think that we've seen our - we'll call it budgeting process, play out here this year. As we've articulated, we start the year with a range of expected outcomes on the top line. We start the year with a spend run rate. And as we progress through the year, as we get more comfortable, we release more incremental funding into the system. So that's how we try to gauge it and we would continue to try to do that and we're frankly doing it right now already in preparation for next year and that's how we're thinking about it. So we're really talking about modulating incremental expense into next year and hopefully not putting ourselves in a situation where we've got to actually pare back expense. I think we feel pretty comfortable about it. [Operator Instructions]. Our next question comes from the line of Adam Borg with Stifel. Adam Borg Neil, maybe for you, it's great to hear the continued kind of turning over all the stones as you take a fresh look at the entire organization. As we think about go-to-market and potential changes there, how do we think about the potential risk of disruptions from those changes in the near term and how is that contemplated in guidance? Neil Barua One of the benefits of having been here now 18 months, maybe a little bit longer, is I've had the time to process, be part of the organization, to think through and observe. I'm part of a number of customer conversations, etc. I've had a great transition process with Mike DiTullio, as I mentioned, and I feel confident that my thoughtfulness, our thoughtfulness around what to change from position of strength, not a position of weakness, is actually a very exciting thing for many people here at PTC to make sure we're enabling them to be as successful as they can across these five priorities. So I actually believe that the work we're doing fundamentally is going to be a huge value to a lot of people here at PTC to unleash even greater work that they've been doing. And so, to that end, these are going to be very intentional moves. I've done it a number of times in my career and it's to drive more effectiveness and I feel really good about our ability to manage through these changes. Adam Borg Maybe just a quick housekeeping for Kristian. I know we lowered the top end of the ARR range by $20 million and I apologize if I missed it. I think last quarter it was lowered due to some ARR contracts being renegotiated, more deferred ARR. Is that what we're talking about here or is there something different? And I apologize if I missed it. Kristian Talvitie No, there were no other changes to the deferred ARR, like we talked about last quarter. This was simply reflecting - this is I think what Neil was saying earlier, reflecting how our Q3 results came in and the composition of those deals and how they roll into ARR in Q3 and Q4 and beyond and the outlook to the best of our ability for Q4 as well, given the deals that are in play and the pipeline and expectations around what the composition of those deals is going to look like as they materialize into ARR. Our next question comes from the line of Joshua Tilton with Wolfe Research. Joshua Tilton I actually kind of want to follow up on that last question. I want to ask a little differently. Kristian, I always appreciate your cabin teach-ins. And one of the things you emphasize is kind of the relationship between ARR and free cash flow. And I guess if I look, free cash flow missed by $10 million in the quarter and you're also lowering the midpoint to the full year ARR number by $10 million as well. Kind of implies that there was a $10 million dollar deal or $10 million of ARR that should have landed this quarter and is no longer in the guidance. I guess, is that the right read? And if so, is that because the deal is going to close in later periods or is this just you guys being prudent? Any color there would be great. Kristian Talvitie It's a great question, Josh. No, and that actually is not the case at all. On free cash flow is actually simply timing. Just being completely candid, we had a bunch of collections that were due in the last two days of the quarter. The last two days of the quarter happened to be a Saturday and Sunday. We were hopeful that we were going to get that cash in on Friday or before, but obviously customers have a contractual right to actually pay it the following week. And so, that's what happened on the cash flow. We were hopeful that we were going to get it on the week before. We've now got that cash, so hence there's no change to the cash flow forecast for the year. That's the timing issue. Joshua Tilton And just to confirm also, more of a clarification, I think heading into the second half, you guys still had $10 million more in deferred ARR in the balance this year versus last year. Is all $10 million of that remaining? Some of that recognized this quarter. Can you just help us understand that? Kristian Talvitie Yeah, it was about half of it in last quarter and half of it this quarter. Sorry, I'll be more precise. Half of it in Q3 and about half of it in Q4. Our next question comes from the line of Saket Kalia with Barclays. Saket Kalia Neil, maybe for you, it feels like close rates is one of, if not maybe the major reason here for just the revised ARR guide. And so, the question is, can we maybe talk about that metric anecdotally, of course, for ServiceMax and Codebeamer cross-sell? I know the team really enabled PTC sellers to go after those opportunities this year. How has that sort of trended and kind of how are you feeling about those businesses when you think about kind of close rates? Neil Barua Let me make a piece of this clear around close rates. Our assumption going into Q4 about close rates and looking at a deal by deal match ratio of the pipeline is no different than our view of close rates that have been evident for the most part in general for the last few years. The dynamic of what we're doing on Q4 right now in terms of guidance, how we think about it is we now know what happened in Q3. We now know the composition, meaning how the deals that we closed in Q3 are going to actually go into ARR, whether they all came into Q3 or whether part of it goes into Q4 ARR or part of it goes into the next subsequent years. So now we have that data point. We have now made the assessment around all the deals that are maturing in the pipeline and the close rates is consistent with what we've seen prior quarters and years. So it's continued challenge on the close rate, not worse, not better. And we've made assumptions around how that ARR when it closes actually comes into ARR. And that's the area where the precision is difficult for the company, given is it going to be a deal that ramps over time? Is it all going to come into one quarter? And looking at all those factors, we determined the guidance range that we put with the risk and opportunities balance. In terms of PTC and ServiceMax, Saket, what I will say anecdotally is we are continuing to be pleased, excited about the buildup in momentum of Codebeamer and the interest and reception we're getting from the market, the reception that we're getting from customers that are testing out like the example that I gave to you that are thinking about broadening the expansion of the utilization across the company in Codebeamer. And on ServiceMax, the business is starting to work in terms of continued buildup of really good pipeline as well as close that happened for the last year-to-date through Q3 and quite a lot of very interesting deals that we're assuming will close in Q4 to allow for a really strong jump off into next year that we will make sure we continue. So on both fronts, all systems go and we're very pleased so far with the momentum. We still have to close and continue that momentum sustained over the next number of years. Our next question comes from the line of Jason Celino with KeyBanc Capital Markets. Jason Celino How are you baking in - well, let me rephrase, your customers' decision-making, whether it's close rates or pipeline or whether they want to expand, how are they baking in the US election into that process? You serve some industries like automotive and aerospace and defense that are sensitive to that. And then how are you baking that into the guidance framework, if at all? Neil Barua It's the first time in my career where I've been spending so much time with executives and customers across the world, and they ask me who's going to win the election in the US. It's a consistent and quite a confusing time for everyone around what happens in the US. That being said, I think for the most part, customers are understanding that whoever gets put in the office, a lot of things don't dramatically change depending on the composition, what happens across all different constituents of the US election. And so, part of what we're seeing and part of what we're continuing to assume and hearing, most importantly, for our customers is we got to get on with digital transformation, regardless of if this person's in office or that person's in office, because we are not becoming competitive if we can't deliver products faster, with better quality, and a more sustainable cost structure, given all the things that are happening around the world. I will say that geopolitics, the environment, the uncertainty, wars have been consistent for the last number of years, which is why we continue to say we've not said that the environment's getting better. We don't believe it's getting worse based on this. And we're going to navigate through this time period. And we've thought through that in the way in which we set the guidance here. Our next question comes from the line of Matthew Hedberg with RBC Capital Markets. Michael Richards It's Mike Richards on for Matt. So I appreciate the early look into 2025. So maybe how should we be thinking about the drivers of that low double-digit growth and how that sort of evolves from this year as it pertains to the five focus areas? And even acknowledging that it's a decade-long journey for SaaS, maybe how that might contribute more to growth as we move forward. Neil Barua Again, I think we'll get into providing more details when we give the official fiscal 2025 guidance next quarter. Our next question comes from the line of Jay Vleeschhouwer with Griffin Securities. Jay Vleeschhouwer Neil, Kristian, one of our observations about your largest market historically, namely the CAD market, is that over the last year, the share shifting that we have seen in the prior few years, which worked out to your benefit, has somewhat abated. In other words, share seems much more stable of late in that market. If it should turn out that the CAD market becomes increasingly competitive, how do you think about your competitive responses, perhaps in pricing or packaging or some other means? And again, if it were to become more competitive, how might that affect your broader cross-selling initiatives or ability to close cross-selling? And then secondarily, Neil, I liked your comments on the internal stone turning. Could you elaborate on the R&D changes that you're making, particularly in terms of the common platform that you've been working on, namely Atlas, which we frankly have not heard a good deal about lately? Neil Barua On the first part on CAD, we have two awesome ways in which we're addressing the market. As you know, Jay, we've got Onshape, industry's only cloud-native CAD application, and we got Creo, which is awesome, as you know. And so, those two together, we feel have competitiveness. I am not talking about Onshape. It's a great part of our business, building momentum. We feel very good about it, competitive positioning. It's starting to scale. I will talk about it when it has a meaningful impact at an aggregate level to the financials of the business. But, strategically, we continue to make sure our chips are being placed to ensure that Onshape is successful against some of the other solutions that are out there from our competitors. And then you've got Creo, which is a very strong tool. And our belief is the connection of Creo to Windchill and ultimately Codebeamer, the three together, is a very strong value proposition for many customers thinking about how they think about the digital thread. So, Jay, I would say in the CAD business, we're ready, we're competing, we're in several different dynamics of deals that might cause share shifts, might not. As you know, it's not an easy business to do share shifts, but we believe we have a very comprehensive offering on both fronts, industry leading, scale player in Creo, and Onshape, which is starting to hit their stride here and we're going to continue to focus in on it. On your point around turning over stones on R&D, what I'll say is we're focusing in particularly on go-to-market and G&A. We're making sure on R&D, we are focusing on making sure the team is aligned to deliver on the roadmap. Every single one of our customers, Jay, is saying, we love your products, we love where you're going in terms of building feature functionality, scalability of those products, just do it. And so, job number one for the R&D team is keep doing that and do it with precision, energy because our customers need it. So that's number one. Including by the way, the Atlas team, because that is a fundamental layer by which we have the ability to offer our SaaS offerings. And two, continue to build innovative offerings. We're continuing to build ways in which we could add generative AI into our products. We're continuing to do - we just released an awesome integration of ServiceMax to Windchill on-time with great quality on July 11th of this month. We have another release of a ServiceMax ability to - now have ServiceMax able to be sold alongside Windchill in the federal space. So we're continuing to build some of these innovations, including with Codebeamer, Windchill and Creo and Onshape to make sure we're at the best-in-class here. I'll pause there. Our next question comes from the line of Clark Jeffries with Piper Sandler. Clark Jeffries I wanted to ask Kristian, we're asking a lot of questions here about close rates and pipeline, but maybe going back to that framework that you've set around ARR and what you need to believe on a sequential ARR basis. I just wanted to maybe have the discussion on - in relation to that $85 million for Q4, you called out the $5 million related to some of those existing contracts. What is the percentage in that $85 million that's going to come from uplift or pricing, drivers that are relatively in-hand versus new sales or upsells that might be more sensitive to execution? Neil Barua I guess we could take a stab at it. I think I would think about it in a few different buckets. There is some benefit from pricing. As you know, we tend to be pretty customer friendly on that front, but there's certainly some benefit from that. I would say consistent with what's been in the past couple of years. Then I would probably start moving up the stack and thinking about the channel. The channel has been a pretty consistent performer really for a number of years now. And we haven't really seen any meaningful changes in one direction or the other that would indicate a change in the trend there. So that gives us some level of comfort. Then I would move up also more into our kind of base business and base transactions. And again, the kind of volumes that we've seen there have been pretty consistent. And then lastly, you get to the large deals and that's really where the volatility is in any given quarter. And of course, it's also those large deals where you see the other dynamics come into play. Not only is it going to close in the quarter, but if it closes, how much of it's in quarter start? Is it a ramp deal? Is it all starting in the quarter, et cetera? And that's the part that's on a quarter-by-quarter basis difficult to predict with a high degree of certainty. Thank you. I will now hand the call back over to Neil Barua for closing remarks. Neil Barua Thank you, everyone, for joining us today. Here's what's ahead specific to investor conferences. August 20th, Steve Dertien, our CTO, will join the Rosenblatt Virtual Tech Summit Conference. September 4th, Kristian will be at the Citi Global Tech Conference in New York. On behalf of the team, thank you again and we look forward to engaging with you. Ladies and gentlemen, that concludes today's call. Thank you all for joining. You may now disconnect.

Entegris, Inc. (ENTG) Q2 2024 Earnings Call Transcript

Entegris, Inc. (NASDAQ:ENTG) Q2 2024 Earnings Conference Call July 31, 2024 9:00 AM ET Company Participants Bill Seymour - VP, Investor Relations Bertrand Loy - CEO, President & Chairman Linda LaGorga - SVP, CFO & Treasurer Conference Call Participants Toshiya Hari - Goldman Sachs John Roberts - Mizuho Bhavesh Lodaya - BMO Capital Markets Melissa Weathers - Deutsche Bank Charles Yu Shi - Needham Tim Arcuri - UBS Chris Parkinson - Wolfe Research Operator Good day, everyone and welcome to the Entegris Second Quarter 2024 Earnings Conference Call. [Operator Instructions] I would now like to turn the call over to Bill Seymour, Vice President of Investor Relations. Please go ahead, sir. Bill Seymour Good morning, everyone. Earlier today, we announced the financial results for our second quarter of 2024. Before we begin, I would like to remind listeners that our comments today include some forward-looking statements. These statements involve a number of risks and uncertainties, and actual results could differ materially from those projected in the forward-looking statements. Additional information regarding these risks and uncertainties is contained in our most recent annual report and subsequent quarterly reports that we have filed with the SEC. Please refer to the information on the disclaimer slide in the presentation. On this call, we will also refer to non-GAAP financial measures as defined by the SEC and Regulation G. You can find a reconciliation tables in today's news release as well as on our IR page of our website at entegris.com. And finally, as a reminder, we have included in the earnings slide presentation for your reference, consolidated and divisional P&Ls that exclude divestitures for Q1 and Q2 of 2024 and all 4 quarters of 2023. On the call today are Bertrand Loy, our CEO; and Linda LaGorga, our CFO. With that, I'll hand the call over to Bertrand. Bertrand Loy Thank you, Bill, and good morning. I am pleased with another strong performance in the second quarter. With semi industry that continues to be in transition, the Entegris team delivered results that were in line or better than our guidance. Sales of $813 million were above our guidance and excluding divestitures, were up sequentially in all 3 divisions. Gross margin increased sequentially and was up over 300 basis points year-on-year, in line with expectations, showing strong execution and the benefit of our recent divestitures. And EBITDA and non-GAAP EPS were within our guidance range. Looking more closely at our sales performance, Second quarter sales increased 10% sequentially and 6% year-over-year, excluding divestitures. Sales were up across most product areas. For our unit-driven revenues, sales were particularly strong in CMP slurries and pads, liquid filtration and etching chemistries. Our CapEx-driven revenue also rebounded sequentially in the quarter. This was true for facilities-based CapEx products like gas purification and fluid handling as well as for WFE-related CapEx products like groups and gas filtration. Let me cover a few other business highlights. Last month, we announced a preliminary award of up to $75 million and proposed a direct funding under the CHIPS & Science Act to support our new manufacturing facility we are building in Colorado. We are honored to be the first material supplier to be awarded funding through this federal initiative, validating the importance of what we do as a key enabler of the semiconductor industry and its ecosystem. We expect to receive the funding and installments tied to the achievement of several milestones over the next 4 years. The first phase of this project will include the production of FOUPs and proprietary membrane used in our photoresist liquid filters. Initial sales from this facility are expected to be generated in the second half of 2025. I'm also pleased to report that our new facility in Kaohsiung, Taiwan, continues to be on track to ramp up production. We generated our first revenue from this new facility in Q2, a great milestone for our local team and we continue to expect to generate approximately $40 million in revenue from this facility for the full year 2024. Our investments in both Taiwan and Colorado, will provide manufacturing capacity to support the significant growth we expect in the coming years. On that note, we are continuing to make significant R&D investments that are critical to capturing the many growth opportunities ahead of us. In support of this, we expect our R&D spending will increase 15% in 2024. Our customers technology road maps are calling for new materials innovation and ever greater process purity to achieve optimal yields, an incremental device performance. The compounding process complexity of these road maps is making our expertise in material science and materials purity increasingly valuable to our customers. The investments we are making in fundamental research and new product platforms are expected to translate into key wins in the new nodes, further solidifying us as a critical enabler of our customers' technology road maps, providing us with excellent growth opportunities going forward. Moving on to our outlook for the balance of the year. 2024 continues to be a transition year for the semiconductor market. Industry inventories are normalizing, and fab utilization rates are broadly improving. These recent trends validate that the industry reached the bottom of the cycle in the first quarter of this year. We expect the market will continue to gradually recover in the second half of this year and will accelerate entering 2025. For 2024, including 2 months of the PIM business, which we divested in March, we now expect our sales will be approximately $3.3 billion. This modest reduction in our 2024 sales outlook primarily reflects slightly slower-than-expected market recovery in the back half of the year and the negative impact of foreign exchange versus our original assumptions. Excluding divestitures from both 2023 and 2024, our full year guidance amounts to approximately 7% top line growth versus 2023 and approximately 11% growth in the second half versus the first half of this year. We continue to expect EBITDA to be approximately 29% of revenue in 2024, and we now expect non-GAAP EPS in to be approximately $3.15. Let me now turn the call over to Linda. Linda? Linda LaGorga Good morning, and thank you Bertrand. Our sales in the second quarter were above our guidance at $813 million, up 6% year-over-year and up 10% sequentially, including the impact of divestitures from prior periods. On an as-reported basis, our sales were down 10% year-over-year and up 5% sequentially. Foreign exchange negatively impacted revenue by $10 million year-over-year and by $4 million sequentially in Q2. Gross margin on a GAAP and non-GAAP basis was 46.2% in the second quarter within our guidance range. The higher margin compared to Q1 primarily reflects improved plant utilization, focused execution and the PIM divestiture. Operating expenses on a GAAP basis were $246 million in Q2. Operating expenses on a non-GAAP basis in Q2 were $197 million. Adjusted EBITDA in Q2 was $226 million or 27.8% of revenue within our guidance range. Net interest expense was $53 million in Q2. The GAAP tax rate in Q2 was 9% and the non-GAAP tax rate was approximately 14%. GAAP diluted EPS was $0.45 per share in the second quarter. Non-GAAP EPS was $0.71 per share and within our guidance range. Sales for our MS division in Q2 were $342 million. Sales were up 8% sequentially, excluding the impact of divestitures. The largest contributors to the sales increase were CMP slurries and pads as we benefited from improving trends in memory, specialty coatings and etching chemistries. On an as-reported basis, sales were down 2% sequentially. Adjusted operating margin for MS was 20.7% for the quarter. MS adjusted operating margin was up slightly sequentially, excluding divestitures. The modest increase in margin was driven by higher sales volumes partially offset by increased R&D spending. Our AMH division sales in Q2 of $188 million were up 16% sequentially. The largest driver of the sequential sales increase in AMH was the rebound in our CapEx solutions, led by FOUPs, sensing & control and fluid handling products. Adjusted operating margin for AMH was 15.4% for the quarter. The modest sequential increase in margin was primarily driven by higher sales volumes. Our MC division had record sales in Q2 of $294 million, up 10% sequentially. The Revenue was up across most product lines, including gas purification, liquid filtration and gas filtration. Adjusted operating margin for MC was 31.9% for the quarter. The modest sequential decline in margin was primarily driven by increased investment in R&D. Moving on to cash flow. Second quarter free cash flow was $52 million. CapEx for the quarter was $59 million. We continue to expect to spend approximately $350 million in total CapEx in 2024. A significant portion of the incremental spending in the second half will be related to our new facility in Colorado. During the second quarter, we paid down $55 million in debt from cash on hand, which means to date, we have paid down approximately $1.9 billion of total debt since the close of the CMC acquisition. The blended interest rate on the debt portfolio is approximately 4.9%. And since the term loan is fully hedged, currently, 100% of our debt is fixed. At the end of Q2, our gross debt was approximately $4.2 billion and our net debt was approximately $3.9 billion. Gross leverage was 4.7x and net leverage was 4.3x. We remain committed to maximizing free cash flow and debt repayment. Based on the pace of the market recovery, we now expect gross leverage to be slightly above 4x at the end of 2024. Moving on to our Q3 outlook. We expect sales to range from $820 million to $840 million. We expect the EBITDA margin to range from 28.5% to 29.5%. And we expect GAAP EPS to be $0.51 to $0.56 per share and non-GAAP EPS to be $0.75 to $0.80 per share. Let me provide additional modeling information for Q3. We expect gross margin of 46% to 47%, both on a GAAP and non-GAAP basis. GAAP operating expenses of $238 million to $242 million, and non-GAAP operating expenses of $191 million to $195 million. We also expect depreciation of approximately $47 million. Net interest expense of approximately $53 million and a non-GAAP tax rate of approximately 15%. I'll now hand it back over to Bertrand for some closing remarks. Bertrand Loy Thank you, Linda. In closing, I am pleased with our strong performance and the team's execution in the first half of this year. Our performance to date and the double-digit growth we expect in the second half of the year will drive Entegris above-market growth for all of 2024. And the setup for next year is looking very promising. We feel good about the improving fundamentals of the semi market, and we expect growth to accelerate into 2025. More importantly, our investments and customer engagements are positioning us very well to earn new wins in new nodes. All of this translates into significant growth opportunities for Entegris, expanding our content per wafer and ultimately driving significant market outperformance. With that, operator, let's open the line for questions. Question-and-Answer Session Operator Mr. Loy, thank you. [Operator Instructions]. We'll take our first question today from Toshiya Hari at Goldman Sachs. Toshiya Hari Bertrand, maybe my first question is on the market outlook. You talked about a slower market recovery in the back half. You also talked about FX being a bit of a headwind. On your first point about the market recovering at a slower rate, I was hoping you could expand on that. Is it both CapEx and wafer starts? Or is it more wafer starts? And then by end application, based on what your customers have said and what your peers have said, it seems like leading edge is, if anything, a little bit stronger and sort of the commentary and the data points from the memory and storage space seem quite constructive. So I'm curious what's driving the slightly weaker outlook into the second half. And again, if you can contextualize the FX impact, that would be helpful, too. Bertrand Loy Sure. So let's start with the industry. So a little bit lower assumptions on wafer starts. Right now, we're expecting wafer starts to be up about 3%. And -- so a little bit less than our original assumption when we started the year. We expect, on the other hand, CapEx to be a little bit stronger in the low to mid-single digit. So that's the blend of -- that gets you to about 3% industry growth. I think that what is driving that revised outlook in terms of wafer starts. So as you mentioned, a lot of strength in advanced logic, driven by AI primarily, and that translates into our business, our advanced foundry business is growing very rapidly this year as a result of the strength that we are seeing in advanced logic. Memory, certainly in a better state than last year. We are seeing strength in high-bandwidth memory, obviously, but NAND is still suffering from elevated inventories and then demand for NAND is still relatively soft in most applications. So if you think about wafer starts in memory, both in DRAM and NAND. In fact, we're not back to the levels of wafer start of pre-COVID. So recovery, yes, but slow recovery in terms of wafer starts. And that's really what is driving our business, as you know. And then, of course, you have mainstream, and we're seeing industrial and automotive, in particular, the demand there has been declining in Q2, and the deterioration is certainly worse than our original forecast, and we expect many of our customers to cut production in the second half of the year. So that's really the blend that gets you to that 3% wafer start outlook for the year. So more broadly, I think you're asking me to provide a bit more color on the reduction in the annual guidance. There are 3 buckets, 2 that I cited in my preliminary remarks. So that's the slower market recovery. That accounts for about $25 million or so of the reduction for the annual outlook. Foreign exchange accounts for about $15 million, roughly. And the last one is specific to SiC. So what's behind those numbers? I mean the slower market recovery, I think I talked about that again, the broad-based recovery we originally expected in the second half is being delayed, and it accounts for that $25 million. We've seen on the foreign exchange -- we've seen a lot of movements in the first half of the year, and the rates today are very different from what we used early in the year to set the original guidance. Then SiC is still a growth area for us. We expect our SiC business to grow 30% this year, which is very good, but it is less than the original 50% growth expectation that we had for this business starting the year. So that's the overall context for the reduction in our annual guidance. Toshiya Hari Yes. And then as my follow-up, maybe on your rate of outperformance versus the broader market. I think you've been saying 4 to 5 percentage points of outperformance for '24, given your SiC comment there at the very end. Maybe that's come in a little bit, but curious where you stand in terms of your outperformance in '24. And then for 25, I know it's really early, but in the past, you've talked about things like gate all around and potential adoption of moly and 3D NAND. What's kind of your confidence level as it pertains to your ability to outperform the broader market into '25? Bertrand Loy Yes. So I think that you -- I think you understand all of those numbers pretty well, Toshiya. So when it comes to the outperformance in '24, right now, we expect to outperform by 4 points. I mean you know that node transitions are a major driver for our outperformance. And you also know that these transitions have been very limited this year. We expect that to change significantly in 2025 and a lot of reasons to be excited in terms of what we expect in advanced logic with the transition to N2, transition to gate-all-around architectures. And as you mentioned, 3D NAND, a lot of expectations in terms of the adoption of moly and high-volume manufacturing in 2025. So again, we have always said that it's harder for us to outperform the industry when you are in a state of transition, and that's exactly the type of year that we're facing in 2024. So in that context, an outperformance of 4% is, in my opinion, at least a good outcome. Operator John Roberts at Mizuho, you have our next question. John Roberts We had some restrictions on exports into China products for leading-edge applications over a year ago and things have been relatively stable since then. Do you see further restrictions as a potential risk or maybe just tariff risk here, but not outright restrictions. Any thoughts on that topic? Bertrand Loy Well, we won't speculate on potential new rules and regulations around trade with China. We obviously have been complying with the existing rules. We have quantified the impact to our business, which is about $20 million of lost revenue per quarter, so about $80 million on an annual basis. We have seen that reduction in late 2022, early 2023. And since then, I'm pleased to say that our China business has been actually performing really well. We have a lot of international customers in China. There are a lot of mainstream fabs in China. And our business with these customers have been actually growing very steadily. Again, I'm not going to speculate on potential new restrictions. But as of right now, we're very pleased with the performance of our business in China. Operator Our next question will come from Bhavesh Lodaya at BMO Capital Markets. Bhavesh Lodaya If I look at your third quarter EBITDA guide and then the full year guide, which was slightly reduced but not that much. you're implying a very strong fourth quarter, almost 25%, 30% higher sequentially versus the third. Can you touch on what's driving that? Are you seeing that in your order books? Or in general, what's the confidence level for the fourth quarter ramp? Linda LaGorga Bhavesh, it's Linda. Thanks for the question. Let me frame the answer for you. So first of all, the full year guide of approximately 29%, we haven't changed. As we go through the year, we're balancing the investing in the business with the cost control. And so we took that into the account as we thought about EBITDA margin for the full year. As we go into the fourth quarter and you think about how that EBITDA margin might progress, some of the keys are with our expectation on the overall guidance and the continued gradual recovery and growth in sales as we go into the fourth quarter, we're going to get the benefit from both volume and operating leverage. So those 2 things combined are going to allow us to have a stronger EBITDA margin as we go into the fourth quarter and therefore, give us confidence in the approximately 29% for the year. Bhavesh Lodaya Got it. And then with respect to your third quarter guide, can you talk about the factors driving the low end and the high end of the guide? The low end, in particular, shows not much growth sequentially. So just trying to understand the factors as we head into the third quarter. Bertrand Loy Yes, Bhavesh, I mean it's -- look, I mean, I think right now, what makes it very difficult to forecast is the fact that various segments in the industry are recovering at very different times and rates. And when we were putting our guidance together and our outlook for Q3 and the balance of the year, I mean you really almost have to go to a customer-specific discussion. It's really hard to generalize. And I can't really give you customer-specific details on this call. But at a high level, I would say that it really has to do with the level of reduction in production in mainstream, I mean it's -- again, it's very different customer-by-customer. We know that some customers are expected to manage the output manager inventory a lot more aggressively than originally expected. And then the other thing is memory. Again, there's a lot of nice recovery. But when you look at wafer starts, as I mentioned earlier, they are still below pre-COVID. I think we are seeing a gradual recovery, which is encouraging. But we know that HBM capacity is limited. I know that the industry is obviously feverishly working to expand that, but the question is how much of that will we be able to see in Q3 as opposed to going into Q4 and in 2025. So I think we feel good about the guidance for Q3. And again, what would sway us one way or another is really very much customer specific. Operator Our next question will come from the line of Melissa Weathers at Deutsche Bank. Melissa Weathers I wanted to double click on your CapEx -- your industry CapEx commentary. I understand the wafer start forecast is coming down a little bit, but you did say that CapEx is coming up a little bit. So can you talk about what's driving that? Is there any particular areas of strength that give you more confidence in that growing faster this year? Bertrand Loy Yes. So what we're seeing is we're seeing WFE actually growing in the mid- to high single-digit. We expect fab construction to remain relatively flattish this year. So my comment is really the net effect of those 2 parts of the CapEx number. Remember that our business is more exposed to fab construction, about 2/3 of our CapEx revenue ties to fab construction, 1/3 ties to WFE. Melissa Weathers Got it. Kind of along those lines, could you talk more specifically about your FOUPs business? I think last quarter, you talked about that business having troughed in the first quarter. So how should we think about the more unit-driven FOUPs business, start 2024 and into 2025? Bertrand Loy Yes. So FOUP is the CapEx business for us. And the reason it's a CapEx business as our customers usually would use those products for about 4 to 5 years. So they get eventually replaced but not frequently enough for us to deem them the consumable product. But I'm glad you're asking the question because -- in fact, the FOUP platform did really well sequentially in Q2. It was up nearly 30% sequentially Q1 to Q2. And frankly, one of the reasons why Q3 guidance sequentially is more modest is that we expect our FOUP business to contract in Q3. That business has been notoriously lumpy, especially in periods of transition like we are facing this year. So that business is going to contract a little bit in Q3. We expect that business to expand rapidly in Q4 and then continue to grow in 2025 on the strength of the overall industry. Operator Charles Yu Shi at Needham, you have our next question. Charles Yu Shi So Bertrand, you provided a little bit of color on the product details into Q3. Just want to ask if you could give a little bit more color across the 3 divisions, how things are trending from Q2 to Q3 on a sequential basis. Your comment on FOUPs makes me wonder maybe AMH is going to be down a little bit in Q3, but I wonder if you can provide a little bit more color for all 3 divisions. Bertrand Loy Sure. So I think -- look, I mean I like -- I prefer to look at our Q3 guidance in the context of a year-on-year comparison, right? And in that context, at the midpoint of the range, you're looking at a 10% up quarter in Q3. And you will see actually strength across all 3 divisions compared to last year. We expect MC to be up in the mid-single digits. We expect MS to be up in the mid-teens, and that's excluding divestitures. Then we expect AMH to be up in the mid-single digits. Charles Yu Shi Maybe a question about KSP. I think you guys mentioned that it's on track. It's -- congrats on the initial revenue in Q2. But, just wonder, can you remind us what's the total revenue potential for that facility? And let's say, compared with the time you started building this facility, the ramp in 2024, how does that compare? Is it a little bit lighter? Or is it rather consistent or actually above? I want to get a little bit of color on that. And additionally, I did get questions on how to think about KSP versus the advanced node business that you're getting from the leading foundries in Taiwan? Is it really tied to that? Or the demand from the leading foundry is still largely supported by facilities from elsewhere? Bertrand Loy Yes. So today, obviously, all of the needs of our leading Taiwanese customer and its ecosystem is supported from other factories, right? This is going to change, especially when it comes to advanced filters. We expect the bulk of the advanced filters used by our Taiwanese foundry customers and their ecosystem to come from Taiwan, not all of it, but the bulk of it over time, right? So the full potential -- the full capacity for our Kaohsiung site will be around $500 million at maturity at scale. And this year, really, the focus is on product qualifications, and we are making good progress, but there's a lot of work that needs to happen. We want to be ready for the N2 transition next year. It's important for our foundry customers. It's also very important for their ecosystem. So the focus for us this year is really about product qualifications as opposed to revenue maximization. Having said that -- as I said, very pleased, I think we generated about $2 million in Q2. We expect to generate about $40 million on a full year basis out of this facility. But again, the bulk of the efforts right now by the team is product qualifications ahead of the N2 conversion. Operator Our next question today comes from the line of Tim Arcuri at UBS. Tim Arcuri Sorry, I got kicked out of the call for a moment. So I apologize if this has been asked. But Bertrand, I'm sure you've seen the news reports and even there was one today about expanding the use of FDPR to further restrict -- well, I mean, we can debate what they're trying to do, but they're certainly trying to expand the use of the FDPR and potentially even go after some of the Chinese equipment company. So -- and it seems like this is extending into the subsystem world, too. I mean it's not material per se, but it's but it's subsystems. So I know that I asked you about this a lot, but I mean, you're in pretty close contact with the Department of Commerce. Do you see any potential that materials and just the subsystems world that you sort of generally live it as being swept into the restrictions? Bertrand Loy So Tim, it's a fair question. I mean, as you know, we've been very, very involved in working with the commerce department -- working also as part of the semi consortia, but we don't have any specific knowledge around that, right? And we certainly don't control the outcome of those decisions. So I'm sure you understand, but we won't speculate on what may happen in the future. Tim Arcuri Okay. Yes. I get that. And then I guess just relative -- and I don't know if this question was asked, but I mean, certainly, we're seeing N3 is certainly -- at least from an equipment perspective, there are shipments being dropped into the end of the year. TSMC sounds more bullish about N3 toward the end of the year and certainly more optimistic about and 2 next year. The capacity forecasts keep on going up. So can you speak -- there was a question before that was sort of trying to get at why you're downticking a bit when your largest customer from a consumption perspective seems to be upticking on these key nodes. Can you sort of try to square that for us again? Bertrand Loy Yes. So our business with our largest customer is going really well this year. This is actually, as you would expect, the fastest part of our business. We certainly expect Q2 -- I'm sorry, N2 to be a very successful node and a big node transition in 2025. And we know that the entire ecosystem is getting ready for that. We expect to see the bulk of that impact in 2025. But frankly, we expect to see some of it at the end of this year in Q4. And that's what is reflected in the implied guidance for Q4. Tim Arcuri Okay, Bertrand. So then just to make sure I understand. So Q4 being taken down, if that's being taken up in Q4. So what is offsetting that in Q4? Bertrand Loy Well, I think, again, as I mentioned, the SiC business is going to be growing at 30% year-on-year, but the original expectation was it -- for it to grow at about 50%. So that's one headwind that we're facing. We are also obviously witnessing a significant contraction in mainstream fab activity, both because demand from their automotive and industrial applications is coming down because a lot of their customers are really focusing on reducing inventory levels, and our customers are adjusting their fab production schedules accordingly. So that's something that we are taking into account as we revise the overall, I mean, the second half industry outlook. I mean those are the 2 main drivers. Operator Our next question comes from Aleksey Yefremov at KeyBanc Capital Markets. Unidentified Analyst This is Ryan [ph] on for Aleksey. Just one from me. I wanted to kind of drill in some margins a little bit sequentially from 2Q to 3Q? Obviously, you guys are kind of guiding margins to be up. Just wondering on a segment basis, kind of where you expect that strength to come from and what's giving you confidence there? Linda LaGorga So to me, it's really an overall strength. So there is some uptick in revenue as you can see. And as we continue to see that uptick, we will continue to see volume leverage. As you think about Q2 to Q3 also, we have the OpEx number coming down a bit. So we're getting that OpEx leverage and the OpEx as a percent of revenue will be coming down as we go through Q3 and into Q4. So the general recovery as it happens, we're going to see that benefit in our margins. Obviously, we have a little bit of pressure throughout the year that offsets some of that benefit as we go from Q3 to Q4 as we continue to ramp KSP, as Bertrand referenced and focus on the qualifications. Operator And our final question today comes from the line of Chris Parkinson at Wolfe Research. Chris Parkinson Great. Can you just talk a little bit more about how we should be thinking about and modeling the ramps, not only about in Taiwan more near term, but any preliminary thoughts on Colorado as well? Just any color would be greatly appreciated. Linda LaGorga Sure. So in our industry, as we all know, as we're building capacity, we're going to have plants -- that we're building the capacity, focusing on the qualifications and therefore, in advance of the revenue. So on KSP, the way I would think about 2024 is the gross margin headwind year-over-year is about 80 basis points. This year, the Colorado facility is not in service yet. We're building it as we go into '25 and speak about '25, we will have some margin pressure as we ramp up into the revenues. As we mentioned earlier, revenues for Colorado will come in the second half of the year. So that's how I think about the 2 facilities at this point in time. Chris Parkinson Great. And just a real quick follow-up. Just on the balance sheet, the deleveraging process. Obviously, it's been a bit of a journey in the last few years. Can you just remind us -- just given your free cash flow outlook for the second half as well as your projected conversion for '25 -- just any preliminary update on uses of cash and how you're thinking about the balance sheet, what you're hearing from shareholders, so on and so forth. Linda LaGorga So with the balance sheet, I'm very pleased with us controlling what we could control. And what we've done to-date is we've used proceeds from divestitures to pay down debt, and we're using our free cash flow to pay down debt. We will continue to stay focused on using that free cash flow to pay down debt. We are absolutely committed to continuing to reduce our leverage. Since the acquisition of CMC, we have paid down $1.9 billion of debt. But as we go through this year, we still want to make sure we're balancing investing in the business with the debt pay down. So as I mentioned earlier, if that all comes together, we expect leverage to be slightly north of the 4.0x based on the timing of the recovery this year and the timing of cash flow coming in, but we still remain very committed to getting that leverage down further? Bertrand Loy Yes. I mean, to that, I would say, look, we're very focused, obviously, on honoring the commitment we made to bring down the leverage as quickly as we could. Having said that, I'm very, very proud of what the team has been doing this year. This is, again, a transition year for the industry. And we've been able in spite of that, to make all of the required strategic investments that would be critical to our future success. Investing significantly in CapEx this year and last year, continuing to invest in R&D -- I think I mentioned the increase in R&D of about 15% year-on-year. And all of that is really, really important to set for of future success. So those investments in technology, in capacity and redundant manufacturing capabilities, all of that will ultimately translate into significant competitive advantage for Entegris. So I'm glad that we're able actually to do all of that and operate within our target model -- on the target model that we presented during the Analyst Day in January of this year. So a tough year to navigate overall, but I think the team is performing really well. Operator And that was our final question in the queue today. I'd like to turn the floor back to Mr. Bill Seymour for any additional or closing remarks. Bill Seymour All right. Thank you for joining our call today. Please reach out to me directly if you have any follow-ups. Have a good day. Thank you very much. Operator Ladies and gentlemen, this does conclude today's Entegris Q2 '24 conference call. We thank you for your participation. You may now disconnect your lines.

DuPont de Nemours (DD) Q2 2024 Earnings Call Transcript

Chris Mecray - Vice President of Investor Relations Lori Koch - Chief Executive Officer Edward Breen - Executive Chairman Antonella Franzen - Chief Financial Officer Thank you for standing by. My name is Pam [ph] and I will be your operator today. At this time, I would like to welcome everyone to the DuPont Second Quarter 2024 Earnings Call. [Operator Instructions] I would now like to turn the conference over to Chris Mecray. You may begin. Chris Mecray Good morning and thank you for joining us for DuPont's second quarter 2024 financial results conference call. Joining me today are Ed Breen, Executive Chairman; Lori Koch, Chief Executive Officer; and Antonella Franzen, Chief Financial Officer. We've prepared slides to supplement our remarks which are posted on DuPont's website under the Investor Relations tab and through the webcast link. Please read the forward-looking statement disclaimer contained in the slides. During this call, we'll make forward-looking statements regarding our expectations or predictions about the future. Because these statements are based on current assumptions and factors that involve risks and uncertainties, our actual performance or results may differ materially from our forward-looking statements. Our Form 10-K, as updated by our current periodic reports, includes detailed discussion of principal risks and uncertainties which may cause such differences. Unless otherwise specified, all historical financial measures presented today are on a continuing operations basis and exclude significant items. We will also refer to other non-GAAP measures. A reconciliation to the most directly comparable GAAP financial measure is included in our press release and presentation materials that have been posted on DuPont's Investor Relations website. Good morning and thank you for joining. I'm excited to be here today for my first quarterly call as CEO and to be joined by Antonella, our newly appointed CFO. We both look forward to partnering with Ed and our global teams to continue to drive value creation for all stakeholders. We remain focused on driving results and demonstrating the performance potential of our combined portfolio while furthering the plans to unlock value through our previously announced separation. This morning, we reported second quarter financial results ahead of our previous guidance, reflecting continued positive momentum led by broad-based electronics recovery as well as sequential improvement from all W&P lines of business. We were very pleased with this outcome and by the continued focus and strong execution of our global team. On a consolidated basis for the quarter, we saw improvement across all key financial metrics. Net sales and operating EBITDA were both up year-over-year and sequentially, including a 17% pickup in operating EBITDA versus the first quarter. We saw strength in the semi business driven by growth in advanced technology applications, including AI. We also realized continued recovery and new wins within consumer electronics market to drive both year-over-year and sequential growth for interconnect solutions. We did see some favorable timing benefits within each of these businesses during second quarter relative to our expectations. In the W&P segment, we were pleased to see a better-than-anticipated sequential step-up in our water business in China as well as improvement in Tyvek medical packaging within Safety Solutions which was in line with our expectations. Our year-over-year growth in operating EBITDA reflects solid margin expansion with operating EBITDA margin improvement of 130 basis points, driven by favorable business mix, stronger production rates in our electronics businesses and realization of restructuring-related cost savings, partially offset by higher variable compensation expense. Second quarter adjusted earnings per share increased 14% year-over-year. Strong cash generation and related conversion of over 100% was another bright spot for the quarter, highlighting disciplined working capital management and made a sequential sales ramp. For the full year 2024, we are raising our guidance for net sales, operating EBITDA and adjusted EPS which Antonella will detail shortly. I also wanted to highlight that earlier this week; we closed our acquisition of Donatelle, a manufacturer of sophisticated medical devices. We are delighted to welcome the Donatelle team to DuPont and are excited about this transaction which will deepen and complement our expertise in medical device market alongside Spectrum which we acquired last year. Donatelle will be managed within our E&I Industrial Solutions line of business alongside the Spectrum team. Together, these offerings are expected to enhance our position as a partner of choice for customers in the high-growth medical device field. I'll now turn the call over to Ed, who will provide a progress update on our planned separation. Edward Breen Thanks and good morning, everyone. As seen in our second quarter results, we are well into the recovery phase from last year's inventory corrections in most key end markets and electronics may be setting up for a prolonged positive cycle. Turning to the separations; we've received very encouraging feedback since our May announcement of our intent to separate the electronics and water businesses and the formation of 3 independent companies. We believe our investors broadly appreciate the value creation opportunity of having 3 industry-leading global companies with compelling growth opportunities and distinct investment propositions. As we shift gears to ramp up our separation activities, we have also worked to ensure our teams internally are highly motivated to remain focused on serving customers and driving business performance. That remains the top priority and I'm confident our operating teams will continue to execute. As you can see on Slide 4, we have already begun working on the rigorous project management processes necessary to ensure the separation work is executed smoothly. Our teams have plenty of experience to rely on to ensure we stay within the 18- to 24-month time line from our May announcement with all 3 companies well positioned for day 1. One key short-term milestone that has already been completed is the establishment of key work stream leaders as part of our integrated project management team under Lori and Antonella's leadership, along with myself. Key separation work streams underway include legal entity standup, IT separation and stand, our financials and talent selection. A current priority, along with our Board, is to complete executive leadership appointments for electronics and water along with corporate governance aspects including board appointments. We currently anticipate announcements in early 2025. We are also making progress towards the future capital structures of the 3 intended companies. Specifically, during June, we redeemed $650 million of our 2038 bonds and entered into new interest rate swaps that hedged the rate risk on our longer-dated maturities. To the extent that it becomes necessary to repay these bonds, the new swaps hedge the risk of higher debt repayment costs that would occur in a lower interest rate environment. So while it is still early in the process, you can see that the separation work is progressing along and we look forward to updating you as we move forward. Before I turn it over to Antonella, I'd like to mention 1 of the updates detailed in our 10-Q which will be filed later today, specifically around the South Carolina MDL. Now that the water district settlement has become final, the court has indicated a focus on the personal injury cases. Earlier this year, the court ordered cases not involving 1 of the 8 medical patients to be dismissed by August 22 unless certain evidence is presented. About half of the 6,000 cases depending on June 30 are expected to be dismissed on that basis. They can be refiled over the next 4 years if those evidence requirements are later met. We do not, however, expect any trials in 2024 in the South Carolina MDL. With that, let me turn it over to Antonella, who will provide additional details on our financial results and outlook. Antonella Franzen Thanks, Ed and good morning, everyone. I'm excited to be here today and honored to serve as CFO of DuPont. Turning to Slide 5; I will cover our second quarter financial highlights in further detail. Our second quarter results were clearly encouraging. Volume recovery is a key driver of our improved Q2 financial performance. Additionally, our ongoing commitment to drive productivity and operational excellence as well as continued savings from restructuring actions announced last November are also contributing to top line growth, margin expansion and cash flow improvement. Net sales of $3.2 billion increased 2% versus the year ago period, as a favorable portfolio benefit of 4%, reflecting the Spectrum acquisition was partially offset by a 2% currency headwind. Organic sales were flat as a 2% increase in volume was offset by a 2% decrease in price. Higher volume was driven by broad-based growth in electronics markets within semi and interconnect solutions with year-over-year reported volumes up more than 20% and mid-teens, respectively. These gains were partially offset by year-over-year declines in China within Water Solutions as well as Tyvek Medical packaging. However, we did see sequential improvement in these areas, as Lori mentioned. On a segment view, E&I organic sales inflected to grow 8% while W&P organic sales decline moderated to 6%. Organic sales in corporate decreased 5% versus the year ago period. From a regional perspective, Asia Pacific delivered 3% organic sales growth versus the year ago period with growth driven by China, where organic sales were up 8%, led by strong growth in E&I. In other regions, the North America was down 2% and Europe was down 7%. Second quarter operating EBITDA of $798 million increased 8% versus the year ago period as volume gains, lower product costs, Savings from restructuring actions and the earnings contribution from Spectrum were partially offset by higher variable compensation. Operating EBITDA margin during the quarter was 25.2%, up 130 basis points versus the year ago period and up 190 basis points sequentially from first quarter. Additionally, I am very pleased with our cash flow performance as we reported another quarter of strong cash generation and conversion. On a continuing operations basis, cash from operations of $527 million, less capital expenditures of $102 million, resulted in adjusted free cash flow of $425 million. Adjusted free cash flow conversion during the quarter was 104%. Turning to Slide 6; adjusted EPS for the quarter of $0.97 per share increased 14% from $0.85 in the year-ago period. Higher segment earnings of $0.10 and the benefit of a lower share count of $0.09 were partially offset by lower interest income of $0.05, resulting from a reduction in cash on hand versus the prior year. Other below-the-line items totaled a net $0.02 headwind as a higher tax rate and depreciation were partially offset by lower exchange losses versus the year ago period. Our base tax rate for the quarter was 26.4%, up from 23.7% in the year ago period, driven by certain discrete tax expenses as well as geographic mix and earnings. Our full year 2024 base tax rate is now estimated to be at the high end of our prior range or approximately 24%. Turning to segment results, beginning with E&I on Slide 7. E&I second quarter net sales of $1.5 billion increased 15% versus the year ago period, as the Spectrum sales contribution of 9% and organic sales growth of 8% were partially offset by a currency headwind of 2%. Organic sales growth of 8% reflects a 10% increase in volume, partially offset by a 2% decrease in price. At the line of business level, organic sales for semi were up more than 20%, driven by continued semi demand recovery, including AI-driven technology ramps as well as higher volumes for OLED materials led by new product launches. A resurgence of demand for leading-edge materials requiring higher content and accelerated buying in support of new fab capacity, primarily in China, also contributed to the volume increase in the second quarter. Overall, semi fab utilization improved from the first quarter, with average utilization in the mid-70s. Within Interconnect Solutions, organic sales were up low teens, driven by mid-teens volume gains, reflecting continued broad-based consumer electronics recovery, incremental share gains and a demand benefit from AI-driven technology ramps. We also saw earlier-than-expected timing of orders within certain consumer electronics markets that helped volumes in the second quarter. As expected, organic sales for Industrial Solutions were down low double digits, due primarily to ongoing destocking for Kalrez and biopharma markets. On a sequential basis, sales for Industrial Solutions increased 9% during the second quarter, including an improvement in Kalrez and biopharma. Operating EBITDA for E&I of $419 million was up 20% versus the year ago period, driven by volume growth and the impact of increased production rates in both semi and interconnect solutions, savings from restructuring actions and the earnings contribution from Spectrum. These gains were partially offset by lower volume in Industrial Solutions and higher variable compensation. Operating EBITDA margin of 27.8% increased 120 basis points versus the year ago period. Turning to Slide 8; W&P second quarter net sales of $1.4 billion, declined 7% versus the year ago period due to a 6% organic sales decline, of which 4% related to volume and 2% related to price, as well as a 1% currency headwind. Within Safety Solutions, organic sales were down high single digits versus the year ago period on lower volumes, driven mainly by channel inventory destocking for Tyvek Medical Packaging. However, we did see a sequential increase of more than 20% in this end market, confirming a recovery is in process. Within Water Solutions, organic sales were down high single digits versus the year ago period, driven primarily by lower volumes resulting from distributor inventory destocking. Market conditions in Water Solutions also improved during the second quarter with net sales up 12% sequentially which was ahead of our expectations and driven primarily by an initial recovery in China. Shelter Solutions sales increased low single digits on an organic basis due to demand improvement in construction markets compared to the prior year period. Operating EBITDA for W&P during the quarter of $344 million was down 7% due to lower volumes and higher variable compensation, partially offset by the impact of lower product costs and savings from restructuring actions. W&P saw a nice step-up sequentially from the first quarter in both the top and bottom line with nearly 50% incremental margin. Moving to our outlook on Slide 9; for the third quarter, we expect net sales, operating EBITDA and adjusted EPS to increase sequentially to approximately $3.2 billion, $815 million and $1.03 per share, respectively. For the full year 2024, we are raising our guidance for net sales, operating EBITDA and adjusted EPS. At the midpoint of the revised ranges provided, we now expect full year net sales of about $12.45 billion, operating EBITDA of about $3.085 billion and adjusted EPS of $3.75 per share. Our full year net sales guide reflects about $50 million of incremental foreign currency headwinds in the second half of the year versus prior guidance assumptions which are expected to be partly offset by a sales contribution from the Donatelle acquisition which closed earlier this week. With that, we are pleased to take your questions and let me turn it back to the operator to open the Q&A. [Operator Instructions] And your first question comes from the line of Jeff Sprague of Vertical Research Partners. Jeff Sprague Congrats. Whoever would like to take it. I'd just love to drill a little bit more into electronics. A couple of things you said were quite interesting. First, maybe, is there any kind of inventory rebuild that's going on in that market? Or is this growth you think clearly indicative of what end demand is. And I wonder if you could just elaborate a little bit for us what in the context of DuPont AI-driven demand really means how significant it might be content per chip or anything that you could give to provide some perspective on that question. Lori Koch Yes. Jeff, maybe to your first question. So yes, the majority of the growth that we saw within the semi and ICS business was just market recovery but there was probably about $30 million of pre-buy, especially within Asia Pacific, as some of the new fabs come online. So that drove the Q2 performance up a little bit and then it will mute a little bit the ramp into Q3 and the back half of the year. But overall, still really nice recovery in the electronic space. As we have noted, a lot of it is coming from the AI acceleration that's felt in both the semi and the ICS business. In total, AI is about $250 million of sales for us today; so a lot of improvement to be able to drive growth there. Like I had mentioned, it's felt across the board in semi as well as ICS on the packaging and the thermal management side. Jeff Sprague And also on the consumer side of electronics, I think there was a comment about orders being stronger. Is there just some timing issues there. There's certainly some hope that there's a stronger iPhone cycle here into the holidays? Is that what you're starting to see? Any other color there would be helpful. Lori Koch Yes. So the $30 million of pre-buy was probably about $20 million in semi and about $10 million of Interconnect. So on the Interconnect side, it would be a little bit of a timing shift for some of the premium smartphone deliveries. The next question comes from the line of Scott Davis of Melius Research. Scott Davis Lori and Antonella, it's good to have you guys leading the call here. I wanted just to dig in a little bit on price. I was expecting price to be down in E&I but maybe not necessarily in W&P. Is it mostly kind of a pass-through in like tieback? What are the -- I'm trying to picture why price would come down in Water, I guess but perhaps it's just kind of the comps and how you had to raise price into that big inflation pickup at the beginning last year? Maybe just some color there would be helpful. Antonella Franzen Sure, Scott. It's Antonella. So just a couple of quick things that I would mention. I think it's important to keep in mind, particularly in W&P, we had some really strong pricing over the last couple of years. And I would say, particularly, there's a few businesses where our pricing over the last 2 years was about in the mid-teens that more than compensated for any of the cost increases that we saw. So it's not unlikely that we would see a couple of points that we would kind of give back really more just so to maintain share. So to your point, it's really the timing of the price increases that we had. Scott Davis Okay. That's what I thought. And just going back to Jeff's question and this is just -- I'm not an expert in electronic chemicals at all. But is it the same product mix going into AI applications? I assume it's higher volumes per purchase, et cetera but is it the same product? Or are there variations of that? Lori Koch Yes. It's the same product. It's just more content into the space because of the advanced nodes. And so the advanced nodes have more stacks and/or thermal management requirements that require more of our material. So 1 rule of thumb that we point out is in the semi space. MSI is a typical indicator of market growth and we would be 200 to 300 basis points above market growth because of the advanced node exposure that we have. So they need more material to be able to produce the higher-end chips. Scott Davis Okay, that makes sense. That's what I thought. So thank you. Best of luck. Your next question comes from the line of Steve Tusa of JPMorgan. Steve Tusa Congrats everyone in the room there. Just on the guidance, what is kind of normal seasonality now for EBITDA? It looks like it should be up mid-single digits quarter-to-quarter, at least that's kind of what it did last year but you're more in recovery mode, it feels like. So unclear to me why it would only be up a couple of percent like you haven't guided. Lori Koch Yes. I think to your point, we haven't -- yes, so I think you have to go back a couple of years to kind of see the more normal seasonality pattern that would exist. And so if you go back, it's probably more about $50 million to $100 million lift from Q2 to Q3 and then normally about a $100 million decline from Q3 to Q4. So this year's recovery is muting that. And also the pre-buy in Q2 is muting that a bit from Q2 to Q3, so rising about $30 million. But our decline Q3 to Q4 is muted down to about $50 million in the guide, because that's the continued recovery that we see across the board. So seasonality is a bit challenging, to your point, whenever you're having market inflections but that's what's into our number. Like if you take away the pre-buy, then you would see more the normal seasonality. Steve Tusa Okay, that makes sense. And then, Ed, you mentioned the change in the PFAS item there. Where do we stand on like State AG as well as just remind us what the other major moving items around PFAS actually are and how significant this South Carolina News is in the context of what's remaining here. Edward Breen Yes. Steve, there's really 2 buckets left. Obviously, we sell the big 1 on the water district cases. The 2 buckets left in the state AG cases and the personal injury cases. And I think the comment we made this morning on the PI basis, I think, is fairly significant because it reduces the cases from about 6,000 down to about 3,000. And remember, this is not like some of the other settlements we did where we had a location and we settled because we used PFAS. In this case, this is because of firefighting phone again. So only 3,000 cases and this goes back to what the plaintiffs also said in our settlement that we are probably responsible for 3% to 7% as a consortium group and we're only 1/3 of the 3% to 7%. So I think you can wrap your head around a number that's pretty reasonable here. Steve Tusa And I guess for PFAS more broadly though, does that -- I mean for the other guys that are involved, the ones with the larger exposures, I mean, is there any -- I would assume that it's kind of a similar impact to those guys as well. Now -- is there any reason why judging how injured somebody actually is, is different from company to company when it just comes to the basic injury [ph], if you will? Edward Breen No. I think the difference is just to distinguish that we didn't make firefight [ph]. So, if you made it, you're in a different little bit of a category but we did not make it. So -- which is I think why our percent is just 3% to 7% and we're 1/3 of that. I don't expect Steve any settlement this year but we are working hard to settle as much to the rest of the PFAS as we can by the time of the spin to get them out clean. So we're working hard at it. Steve Tusa Yes. You're always working hard. So we appreciate that. Thanks a lot. Your next question comes from the line of Josh Spector of UBS. Please go ahead. Josh Spector I wanted to ask on W&P. Just within the guidance in the context the year-on-year comps get easier, so you're clearly expecting some growth there in the second half. But it kind of seems like you're guiding things somewhat flattish from a sales and EBITDA perspective. So I'd be curious, are you seeing continued improvement from destocking? Are you not? And what are your assumptions around that? Antonella Franzen Yes. So this is Antonella. Just a couple of comments there. So as we mentioned, we did see a nice lift off of Q1 in both medical packaging in Tyvek as well as in our Water business, where we saw the biggest impact of destocking. A we move forward, we do continue to expect that we will see a little bit more lift in medical package as we go through the year. For water, as we mentioned, we actually saw a bigger lift headed into Q2 than we were originally expecting. So that will be pretty consistent. As we head into the third quarter, we'll see a little bit more of a lift in the fourth quarter as well. So overall, revenue is relatively flattish as we go into the second half of the year for W&P. And I would just keep in mind, there's probably a little bit of muted seasonality that we built in, in the shelter business, just given the soft resi market and just we're keeping a close eye on the macros out there. And so that's a little bit of a cautious view, I would say that we have built into our guidance currently. Josh Spector And I guess what about margins? Kind of the same line of thought there. I mean that was a bright spot in the quarter here, getting back to kind of a year ago margins and volumes still down. Is there something incremental negative on the margin sequentially? It seems like you're assuming that's a little bit lower versus what you did in 2Q. Antonella Franzen No. Actually the margins in W&P are expected to be flattish to up a little bit actually as we head into the third quarter and expect it to continue to improve as we head into the fourth quarter as well. Your next question comes from the line of John McNulty of BMO Capital Markets. John McNulty This 1 regarding the split. So you've had the big announcement this past quarter. I guess can you speak to interest that you may be seeing in some of those assets, sometimes there's not a lot of interest until announcements get made and then all of a sudden, people start lining up. So maybe you can help us to think about that, especially around maybe the water business? And if not, I guess I'd also ask, it does look like the M&A markets are heating up in a couple of areas, especially in water. Would you consider bolting on businesses ahead of the split to any of the other assets? Or is that just too much to deal with for the organization at this point? How should we be thinking about that? Edward Breen Yes. Yes. So your last point, no, we wouldn't do anything where we bolt something on the asset. I don't want to get out in front of ourselves on any speculation of what's going on. But as I said on the last earnings call, John, if there is interest in the water business, we obviously will look at it and study it hard if there's a better path to creating value for our shareholders, we would clearly do that. And I'll just leave it at that for now. John McNulty Okay. Fair enough. And then I guess just a question on the PFAS issue. So look, you guys have been doing a pretty good job of cleaning up the liability so far. Earlier this quarter, we had the Chevron decision kind of get overruled by the Supreme Court. I guess I'm wondering, what does that do in terms of how you think about the liability and the ability to put that to rest. Does it change kind of the strategy or how you're thinking about that, what that liability might mean going forward? Edward Breen Yes. So it kind of goes back to the whole superfund circle issue. And to make it very clear, manufacturers of products are not responsible under circle. There's kind of 4 key categories, if you don't mind me telling you these for a minute just to clarify this issue. The responsible parties are current owners and operators of facilities where substances are located, [indiscernible] owners of facilities where hazardous substances were disposed, aggregators and generators, persons who arrange for disposal has a substance at a site and transporters who transported it to those sites. So by the way, there's a Supreme Court case on this, just to clarify it more. An entity will not be held liable as an arranger merely for selling a new and useful product if the purchaser of that product later and unbent to the seller dispose of the product in a way that led to contaminate it. So I think it's pretty darn clear, as we've said all along that we don't have responsibility under this Your next question comes from John Roberts of Mizuho. John Roberts On the spin-off, will we have to wait until the SEC filings for the income statements and debt allocations to the spin co -- or do you think DuPont will begin reporting more like a holding company and give us electronics and water, at least summary income statement, summary balance sheets before the SEC filings. Lori Koch Yes. We intend to report in the new structure prior to the Form 10 detailed filings would go out. So we're targeting sometime early next year to have leadership appointments and then ultimately report on the new segments would be the future spin. John Roberts Okay. And then will new DuPont pen report medical or health as a separate segment? Or is it going to continue to be split across industrial and safety? I think it's going to be over 25% of new DuPont but it's a little hard to see in the current reporting. Lori Koch Yes. So we will most likely have three reportable segments for Remainco, one of which is health care which would be the combination of Tyvek, Spectrum, the Liveo Biopharma business and now Donatelle given that acquisition closed. And the other two reportable segments would be a next-gen mobility which would help all of our EV automotive exposure. And then the remaining would be generally the safety business and the shelter business and the rest of the printing businesses and industrial businesses, industrial solutions that aren't semi related. Your next question comes from the line of Chris Parkinson of Wolfe Research. Chris Parkinson Just two quick questions on E&I. The first is, do you mind just kind -- as we enter into the second half, can you just offer a little bit more color on Semi tech just given some of your commentary around the broader strokes. But if we dig in to pad slurries, you mentioned older materials in your PR as well as the PowerPoint. Can you just help us conceptualize how we are trending into '25, '26 and perhaps into a larger upcycle? Lori Koch Yes. So we expect nice high single-digit growth in the current construct of E&I as we head into 2025, a lot of that coming from the growth acceleration from AI as well as overall continued pickup within the consumer electronics space. So we think we'll be from a utilization perspective on the semi front more in the high 70s as we exit 2024 overall. It's more like in the low 80s in the advanced nodes in DRAM and then lower than that in the legacy nodes and some of the more legacy memory applications. Chris Parkinson Got it. And Lori, I have to bring it back a couple of years, because the follow-up is on ICS and specifically, Laird. When you originally did that transaction, you kind of mentioned AI as an optionality. And obviously, you're kind of -- at the time talking about the shielding the thermal management portfolio there. Can you just kind of help us think about the ICS business as it stands today versus kind of the legacy way of thinking around handsets. It seems like there's perhaps a lot more going on under the hood there in terms of how we should be thinking about sustainable growth rates? Lori Koch Yes. So ICS, I kind of think about it in 2 big buckets as far as market opportunity is concerned. One is like a powerhouse with respect to interconnect solutions and 1 is a powerhouse with respect to thermal management and you see opportunity on the 3 lines of business underneath across both of those segments. And so the Laird acquisition has continued to play out nicely for us to drive opportunity across the ICS portfolio. It's been really timely with the AI boost and the ADAS boost that's coming to have that thermal management business within our portfolio. Your next question comes from the line of David Begleiter of Deutsche Bank. Please go ahead. All right. Our next question comes from the line of Mike Leithead of Barclays. Mike Leithead One on E&I, just strong results mostly across the board with the exception of maybe industrial and you called out the 1 headwind around kind of ongoing Kalrez destocking. I just wanted to dig into that. So your volumes in your sense really consistent with end market trends for the product? Or is there any competitive dynamics impacting Kalrez specifically there? Lori Koch No. No, there's no competitive dynamics. It's really just the destock from the 2023 high volumes that went on. So there's nothing competitively. We did see sequential improvement in Kalrez as we had expected. We actually do forecast of return to volume growth in Industrial Solutions in total in the back half. So it was really just getting through the destock in Kalrez and also in the biopharma which are both in Industrial Solutions. Mike Leithead Okay, great. And then just as a quick follow-up, maybe a question for Antonella on the cash flow statement this quarter. It looks like cash flow from operations for discontinued operations was a $400 million use of cash in the quarter. Can you just help us understand that? Antonella Franzen Yes. So keep in mind, as Ed mentioned earlier, we did have the settlements. So really, that's predominantly all the cash out of about $408 million related to the MOU settlement. Your next question comes from the line of Frank Mitsch of Fermium Research. Frank Mitsch Nice result. If I could stay on the cash flow side of things, Laurie, when you were wearing your prior hat, as CFO. There was an expectation that the second quarter cash flow conversion might be lower than the first quarter in part with interest payments. And obviously, it came in materially above or nicely above, I should say. So can you speak to the factors behind that as well as what the outlook is in terms of cash flow generation? Lori Koch Yes, so good memory. I had signaled that usually, Q2 is a little muted because of the interest payment which we did pay. It was really a reflection of better working capital performance for the most part. So we had sequential revenue but we're really able to keep the working capital headwind. So we've done a really nice job primarily on the inventory front around driving productivity across our businesses to get better at cash. So we're still in that 90% target range for the year, we're at about 96% quarter-to-date. So we're in good shape to be able to deliver against the targets that we have out there. Frank Mitsch All right. Terrific. And then maybe just a second or two in terms of the corporate line. Sales were relatively flat sequentially, yet EBITDA picked up materially. Can you talk about the factors there and what your outlook is? Lori Koch Yes, really, that was driven by a bit of our corporate expenses. So there's always a little bit of timing from quarter-to-quarter. So I would say when you take a look at kind of corporate expenses, we're probably a little heavy in Q1, a little light in Q2 and on average, kind of expected where we would typically be. As you kind of look into the second half of the year, as you look at corporate as a segment, we did point out in the materials that we do expect overall less income coming from corporate in the second half of the year than we had in the first half of the year. Your next question comes from the line of David Begleiter of Deutsche Bank. Unidentified Analyst This is David Hwang [ph] here for Dave. I guess, first, on Industrial Solutions, when do you expect volumes to recover and turn positive here? Lori Koch Yes. We expect volumes to be up low single digits in the third quarter year-over-year for Industrial Solutions and then more in the low double-digit range for the fourth quarter. So we saw a nice inflection sequentially and then we'll see a return to year-over-year volume growth in the second half. Unidentified Analyst And I guess just on the potential water sale. I guess there is some interested parties there. And it sounds like PFAS continue to progress positively. As when you talk to potential interested parties, what's the initial thoughts from them taking over some of the PFAS liabilities? And I guess is there a threshold there willing to accept? Or is it, in general, still a big hurdle for them? And you think if that scenario were to play out, it will not involve any PFAS liability allocation at all? Lori Koch Yes. So we haven't had any conversations on selling the water business. So our intent is still to spend. Each of the 3 spins will pick up their pro rata share of the of the PFAS liability per the trailing 12-month EBITDA underneath the sharing agreement with Corteva. Your next question comes from the line of Laurence Alexander of Jefferies. Laurence Alexander Can you give a little bit more detail on the sequential momentum in Water & Safety Solutions sort of into Q3 and how much visibility here is the visibility improving in those 2 businesses or lead times improving? Lori Koch For the water business, as we mentioned from Q2 to Q3, we do expect it to be relatively flat as we get into the fourth quarter we do expect a sequential increase in terms of the top line. And some of that is just driven by some project-related activity that we have there. In terms of safety, we did talk about that's where our medical packaging business is within Tyvek, we do expect to see some sequential improvement there as well. I think there, the growth will be a little less muted as we go through the course of the year because there's just a couple of little other puts and takes within that business. Your next question comes from the line of Mike Sison of Wells Fargo. Mike Sison Nice quarter outlook. Ed, just 1 question. How do you expect the agencies to assign sort of industry codes for each of the entities of the spin maybe that would help investors assign the right multiple or comps longer term? And I assume you don't expect the entities to get assigned materials or chemicals. But any color on how you think you can help them sort of make that right decision. Edward Breen I'll just say it this way. We are going to work at for. The electronics is very clear where that should be and we will work that issue. I mean there are pure-play comps in those industries that there's only a couple of key competitors against some that have their marking in the water business is the same way; so that will be worked. Lori Koch Yes. And we'll work to get the Remainco SIC code changed as well. So we've been trying for since we spun out of to get a change more to the multi-industrial diversified SIC code. And so I think we continue to make our case that we should not have the chemicals SIC code anymore. And so we'll work with that one as well. Your next question comes from the line of Arun Viswanathan of RBC Capital Markets. Arun Viswanathan I guess just kind of curious on the guidance. So you're raising it by looks like around $110 million or so on the EBITDA line for the full year. The Q2 beat was around $80-something million, so $88 million. So that remaining kind of $22 million, it seems like there could be a little bit of seasonal drop off and maybe some moderation in growth. I know you mentioned the pre-buy $30 million but anything else you'd call out there as to why you're not raising guidance maybe by a little bit more? Antonella Franzen Actually, I would say, our ways in our guidance, when we kind of take a look at it is not only adding in the Q2 beat but actually a bit more than that as well. So kind of the way to look at it is if you look where our previous guidance was and to your point, kind of at the beat that we had in the second quarter of around $150 million on the top and $90 million on the bottom, I think you need to keep in mind that incremental headwind from when we previously gave guidance to the tune of $75 million. And clearly, there's an EBITDA impact associated with that as well. That is only partially offset by the Donatelle acquisition that's going in. So on a true underlying basis, if you put FX and acquisitions aside, in addition to the Q2 beat, we are raising the top line close to $100 million in the bottom line, around $30 million or so. Arun Viswanathan Okay, perfect. And then, I guess just as a quick follow-up. As you look into '25, where are you kind of in that recovery maybe on E&I would you say like where do you expect fab rates to kind of utilization rates to end the year? And do you see those kind of continuing to move up as you move into '25? Lori Koch Yes. I think we'll end the year overall in utilization in the high 70s that will be different between advanced nodes and more legacy nodes. So the advanced node should be in the low 8s and the more mature notes with would not quite be at the average. So it sets up well for 2025 to get back to the more normal utilization patterns that exist in the semi space. As I had noted earlier, we overall probably see high single-digit growth in E&I in total in 2025 with a lot of growth coming from continued acceleration with AI on both the data center side as well as on the ICS side. Your next question comes from Aleksey Yefremov. Next question comes from the line of Patrick Cunningham of Citi. Patrick Cunningham Just on the Donatelle acquisition, first, maybe talk about the strategic fit there and even potential cross-selling opportunities where it's complementary in the portfolio? And then can you also help us size the transaction and how much earnings contribution we should expect in the second half? Lori Koch Yes. So we closed Spectrum earlier this week -- or Donatelle earlier this week. We get up Donatelle nicely with our Spectrum acquisition that we're actually lapping a year on here, August 1. And so they've got nice exposure to some of the large medical device OEMs that Spectrum did not have. So there's a lot of cross-selling opportunity to come in there as they've also got some really nice machining and tooling competencies that will add to the portfolio. In total, the revenue is about $75 million from Donatelle. It's got slightly better margins than what the Spectrum acquisition did. So a nice addition there. Antonella Franzen Yes. The only thing I would add is the $75 million is a full year number, just to clarify. Patrick Cunningham Yes. And then, maybe just a clarification on corporate earnings. I think there was a sizable step-up into 2Q. I know you mentioned there were some expenses that moved around but were there any areas of strength on the underlying retained businesses that helped 2Q? And how much lower should back half earnings be on the corporate line? Lori Koch Yes. So I would say in the second quarter, in addition to the timing of expenses, we did have a good strong margin performance in terms of the retained businesses as well. As we shift into the second half of the year, as I mentioned earlier, we do expect the overall earnings in corporate to come down there is a little bit of pressure that we have in terms of our solar business that we have within the retained businesses. So we have a little bit of earnings headwind related to there. And I mentioned earlier, a little bit of timing related to actual corporate expense. Your next question comes from the line of Vincent Andrews of Morgan Stanley. Vincent Andrews Could I ask quickly on electronics. The timing differences that you called out in the quarter that were favorable to the quarter, are you seeing in your 3Q order book that those are indeed shifted to 2Q? Are you just assuming that? And then we'll see how the quarter plays out. And then separately, Ed, if I could ask you on the PFAS on the personal injury cases, just a little bit of clarification in terms of it sounds like we'll go from 6,000 to 3,000 cases. But has that case count been increasing? Or has it been static around those levels, firstly? And then secondly, on your comments that DuPont is sort of, I think you said 3% to 6% or 3% to 7% sort of the assumed liability. Is that to mean that, that would be your sort of exposure to any payout should there be any? Or is that your exposure to the amount of cases? And lastly on that, how do you expect this to proceed in terms of will something actually go to trial? Will it be the typical MDL where you pick 1 and they pick 1 and you see what the outcomes are and then maybe you try to settle? Or is there a path to settling ahead of time? Or just sort of what you think the process is going to be? Edward Breen Yes. So the cases have crept up over time but the slope has obviously changed, come down. And remember, it's predominantly firefighters. It's not other individuals. So the drop will be at least down to 3,000 of cases. And I'd just say, overall, because it's firefighting foam, it goes back to the last settlement we did where we never made the firefighting foam but we had 1 surfactant that went in for 10 or 11 years. So net-net was determined that the exposure of Corteva [ph] us was in the 3% to 7% range. And so I think you can do the math like we were able to do when we settled the water cases and kind of get this into a certain box. And remember, we're only 1/3 of 3% to 7%, as I mentioned earlier. And Mike, just to your -- kind of one of your last points. Obviously, we always try to settle these as a class, like we did the water cases and we'll work hard to do that. And I said we would love to clean a lot of this up before the actual separations occur. Lori Koch Yes. And maybe on your order question. So our order book is trending alongside the guide that we had given. So we feel like we're in good shape there. And our last question comes from the line of Steve Byrne of Bank of America. Steve Byrne Yes. Your cost of goods were down 2% in the quarter. Can you provide a little more detail on that, such as were raws down more than that? Your volumes being a little higher might suggest that raws were down more than that. But more importantly, where do you think that cost of goods year-over-year is likely to go as we move forward? Antonella Franzen This is Antonella. So a couple of things that I would mention there to keep in mind. So one, obviously, we are seeing a bit of an impact from deflation of cost that's in there. Secondly, I would also mention in terms of restructuring, we took a lot of actions as we announced the program last year towards late November; some of those actions have actually been accelerated. So we are seeing even more of a benefit this year than we were originally anticipating. So as you may recall, we were first expected we'd have about $100 million of restructuring savings in 2024. We now expect that to be closer to $115 million or so for the year. So that's also helping from a COGS perspective and kind of bringing our costs down. Steve Byrne And then you mentioned on Slide 14, a lot of products in development. And you mentioned your water business has some DLE opportunity. Just a question on that. Is this 1 lithium project at a temperate later to that could be many, many years from now? Or is there some breadth to this opportunity that you see in lithium? Lori Koch We continue to see a nice opportunity. We're actually investing in a facility in Europe to be able to take advantage as well from a production perspective. So it's still a little early. I mean, the potential market opportunity on the low end is probably in the $250 million range as we position ourselves as a component supplier into the space. I will now turn the call back over to Chris for closing remarks. Chris Mecray Thank you for joining the call today. As a reminder, our materials are posted on the website, including the transcript from today's call. Thank you for joining. Good day. Ladies and gentlemen, that concludes today's call. Thank you all for joining. You may now disconnect.

Earnings call: Flowserve's earnings per share rise over 40% in 2Q By Investing.com

Flowserve Corporation (NYSE:FLS) has reported a strong financial performance for the second quarter of 2024, with significant growth in revenue and adjusted earnings per share. The company's revenue increased by over 7%, while adjusted earnings per share saw a rise of over 40%. Flowserve's bookings grew to $1.25 billion, marking a 12% increase from the previous year, and the backlog expanded to $2.7 billion. The company also raised its full-year adjusted EPS guidance to $2.60 to $2.75 per share, a 27% increase compared to the previous year, reflecting confidence in stronger performance in the latter half of the year. Flowserve's second-quarter earnings call painted a picture of a company experiencing robust growth and strategic advancements. With the operational excellence program and new product excellence program in place, Flowserve is on track to achieve margin improvements and capitalize on growth opportunities across various industries. The company's focus on leaner seasonality and the anticipation of a stronger second half of the year further bolster the outlook for the remainder of 2024. Despite challenges in specific sectors, Flowserve's overall business strategy and recent acquisitions position it well for continued success and shareholder value creation. Flowserve Corporation (FLS) has shown a promising financial trajectory in the second quarter of 2024, and real-time data from InvestingPro further underscores the company's performance and potential. With a market capitalization of $6.48 billion and a P/E ratio of 25.24, Flowserve appears to be valued significantly by the market, especially given its adjusted P/E ratio for the last twelve months as of Q1 2024, which stands at 22.52. InvestingPro Tips suggest that Flowserve is trading at a high P/E ratio relative to near-term earnings growth, indicating that investors may expect higher earnings in the future. This aligns with the company's raised full-year adjusted EPS guidance. Furthermore, the stock's low price volatility and the company's 18-year track record of consistent dividend payments, currently yielding 1.65%, provide an element of stability for investors. Notably, the company has been profitable over the last twelve months and analysts predict it will remain profitable this year. Key InvestingPro Data metrics that stand out include: InvestingPro offers additional insights and tips for Flowserve, with a total of 7 InvestingPro Tips available, which can be accessed for further detailed analysis. For those interested in a deeper dive, use the coupon code PRONEWS24 to get up to 10% off a yearly Pro and a yearly or biyearly Pro+ subscription at InvestingPro. These insights could be particularly valuable for investors looking to understand Flowserve's position in the market and make informed decisions. Operator: Good day, and welcome to the Second Quarter 2024 Flowserve Corporation Earnings Conference Call. Today's conference is being recorded. At this time, I'd like to turn the conference over to Jay Roueche, Vice President, Treasurer and Investor Relations. Please go ahead. Jay Roueche: Thank you, Melinda, and good morning, everyone. We appreciate you joining our conference call today to discuss Flowserve's second quarter 2024 financial results. On the call with me today are Scott Rowe, Flowserve's President and Chief Executive Officer; and Amy Schwetz, Senior Vice President and Chief Financial Officer. Following our prepared comments, we will open the call for your questions. As a reminder, this event is being webcast and an audio replay will be available. Please note that our earnings materials do, and this call will, include non-GAAP measures and contain forward-looking statements. These statements are based upon forecasts, expectations and other information available to management as of July 30, 2024, and they involve risks and uncertainties, many of which are beyond the company's control. We encourage you to review our safe harbor disclosures as well as the reconciliation of our non-GAAP measures to our reported results, both of which are included in our press release and earnings presentation, and both are accessible on our website in the Investors section. I would now like to turn the call over to Scott Rowe, Flowserve's President and Chief Executive Officer, for his prepared comments. Scott Rowe: Thanks, Jay, and good morning, everyone. We delivered another quarter of strong results with sequential and year-over-year improvements driven by outstanding execution. Compared to the second quarter last year, some highlights include: revenue growth over 7% with adjusted gross and operating margins increasing to 32.3% and 12.5%, while our adjusted earnings increased more than 40% per share. Our strong bookings of $1.25 billion in the quarter, represents a 12% increase versus last year and sequential growth of 20%. With a book-to-bill of almost 1.08x in the quarter, our backlog grew over $70 million sequentially to $2.7 billion, positioning the company for further growth. I want to thank our associates around the world for their passion and dedication to supporting our customers in delivering these impressive results. Continuing with second quarter commentary. Our adjusted earnings per share was $0.73, representing a sequential increase of $0.15 and $0.21 year-over-year. Our bookings are at the highest level since 2014 and included a healthy mix of project awards with ongoing strength in both MRO and aftermarket activity. We generated over $1.15 billion in revenue and increased our adjusted gross and operating margins by 200 basis points and 210 basis points respectively, versus the prior year, which gives us further confidence in our margin progression journey. We are very pleased with our results and the progress we have made in the last couple of years, as we implement and capitalize on opportunities for growth and further improvement. Our operational excellence program continues to deliver results with significant progress within our manufacturing facilities. The new organizational design, combined with improved process discipline is allowing us to operate at a much higher level. While the recent results are impressive, we are confident that there is further upside as we continue to drive maturity in our operations journey. Additionally, we launched our formal product excellence program earlier this year. We have undergone an extensive product portfolio review within one of our seven business units and have identified significant opportunities to deliver higher margins without compromising our focus on growth. We plan to launch this program with our second business unit next month and a third business unit before the end of the year. As discussed at our Analyst Day last year, we have committed to an incremental 100 basis points to 200 basis points of margin improvement from the product excellence program by 2027. The early progress is encouraging, and we expect to begin to see results from this effort in the back half of 2024 and 2025. Operational and product excellence are essential components of the new Flowserve business system that was created to deliver improved process consistency and financial performance across Flowserve. Let me now turn to bookings in our end markets. Our second quarter bookings of $1.25 billion marks our tenth consecutive quarter with bookings over $1 billion. Our 3D growth strategy represents over 25% of our total bookings again this quarter, reaffirming our strategic approach. Our bookings were balanced in the second quarter with original equipment and aftermarket activities each representing about half of the total. For original equipment, we benefited from three large projects in the Middle East, including the two we announced in April. Together, these large awards totaled approximately $200 million. The elevated asset utilization rate and spring turnaround season at our customers' operations led to record quarterly aftermarket bookings of more than $610 million. In addition, we have now delivered seven consecutive quarters above the $550 million level, showing the resilience of this higher margin, faster turn, parts, service and repair work. Flowserve's local presence, strong customer relationships and high levels of service continue to produce solid capture rates on our vast aftermarket entitlement. We expect the world's existing refining, chemical and power facilities will remain at high utilization levels for the foreseeable future and our aftermarket business is well positioned to service their need for continued operability. By end market, oil and gas generated the highest level of dollar growth, representing a year-over-year increase of about 22% and includes two of our three large projects we received this quarter. We also continue to capture a substantial number of 3D bookings that are recorded in this end market, primarily in decarbonization activities such as carbon capture, biofuel conversion, LNG and our energy advantage program. We also demonstrated significant growth within the chemicals market this quarter, booking $272 million. This represented 14% growth versus the prior year and was driven by the Emerald greenfield petrochemical project in Saudi Arabia, which was announced in April. We continue to expect significant chemical capacity additions in the Middle East and modest improvement in overall global chemical demand. We are also making good progress with all aspects of the 3D strategy diversifying into specialty chemicals and plastic recycling, decarbonizing existing petrochemical facilities and adding Red Raven (NASDAQ:RAVN) to flow control products in both existing and new chemical plants. Last quarter, I highlighted the expectation for increases in power generation, driven by the growth in data center capacity fueled by ever-increasing artificial intelligence activity. Second quarter power bookings were $153 million, which represents a 34% increase year-over-year. Additionally, nuclear activity saw particular strength this quarter with more than $70 million in bookings. We continue to be optimistic about nuclear power generation growth for new projects in light -- life cycle extensions in various parts of the world. Another end market we are seeing encouraging signals is the mining industry. As more rare earth minerals and other mine products are needed for batteries, electrical transmission, energy storage and grid hardening, we see stable long-term growth in this sector. Currently, our efforts in mining are included in our general industries bookings and amount to roughly $100 million a year of activity. We plan to increase our organic efforts in mining to capture a larger portion of this expected growth through enhanced channels to market and further new product development. Additionally, as we evaluate inorganic opportunities to create value for our shareholders, further mining exposure would be one area of interest to help fortify our existing offering and achieve our stated goal of diversifying our portfolio of products and services. Turning now to second quarter bookings by region. We saw strong growth in the Middle East on the back of the three large projects as well as modest growth in the Americas. Europe and Asia-Pacific bookings declined slightly year-over-year. Our overall project funnel is up 8% year-over-year, reflecting the continued visibility into significant project opportunities in the Middle East and other parts of the world. Our traditional short-cycle MRO and aftermarket business has proven quite durable, and we expect to see continued growth on this side of the business. As a result, we believe the macro environment and outlook remains favorable for the full control space. We continue to see positive signals driven by the key global megatrends from energy transition and decarbonization to energy security and regionalization to electrification and digitization. Combined, these current and potential megatrends are attracting significant investments. Flowserve is well positioned to capitalize on these trends and drive further growth. In the second quarter, we grew our backlog sequentially by over $70 million to $2.7 billion, positioning us for continued revenue growth. We expect our full year book-to-bill ratio in 2024 will exceed 1.0x and we are off to a good start to the first half of the year with a book-to-bill ratio of 1.02x. Combining our solid performance for the first half of the year with expectations for continued improvement, we have increased our full year adjusted EPS guidance range for the second time this year to $2.60 to $2.75, which at the midpoint represents a nearly 27% increase year-over-year. We are making significant progress at Flowserve, and we believe we are well on our way to achieving the 2027 financial targets that we communicated at last year's investor event. I will now turn the call over to Amy to address our second quarter results in greater detail. Amy? Amy Schwetz: Thanks, Scott, and good morning, everyone. Looking at our financial results in more detail. We generated another quarter of strong sales, nearly $1.2 billion, which combined with improved margins, delivered adjusted earnings per share of $0.73, a 40% increase versus last year. I want to echo Scott in thanking our associates for their continued efforts and execution, which were instrumental in driving both top and bottom line growth during the quarter. Our support of end markets, robust asset utilization by our customers and focused efforts from our sales team led to record quarterly aftermarket bookings of $614 million. Coupled with strong revenue conversion, our operational excellence led margin improvement initiatives and ongoing cost discipline, we generated adjusted operating margins of 12.5%, which represented year-over-year and sequential improvement of 210 basis points and 160 basis points, respectively. With $0.18 of net adjusted items, our reported earnings per share was $0.55. The largest adjusted item was realignment expense, and it was primarily related to our divestiture of the NAF AB control valve business, which principally serves the pulp and paper market. The largely non-cash charge from the divestiture was $13 million or over half the total adjusted amount. The NAF business had modest and cyclical annual revenues and was breakeven at best. This transaction is indicative of how we are optimizing the portfolio by proactively taking action with respect to end markets and products dilutive to the overall business and it's just one example of how we intend to drive further margin improvement across our business. On the strength of our first half results, combined with opportunities we see ahead for the rest of the year, we are narrowing and increasing our full year adjusted earnings guidance range to $2.60 to $2.75 per share. At the new midpoint, this would represent a 27% increase compared to last year's adjusted EPS. To provide context to the phasing of guidance for the balance of the year, we still expect a stronger second half of this year compared to the $1.31 of adjusted EPS we delivered through June 30. Over the past several quarters, we have highlighted steps taken to smooth the quarterly seasonality of our business. And looking ahead, we do expect less differentiation in 2024 than in past years. As you can calculate from our full year revenue guidance, we do expect our year-over-year growth rates to moderate in the second half as we encounter tougher comps. Additionally, while we typically don't provide quantitative EPS, I will say that the third quarter should look operationally very similar to our solid second quarter performance. Our third quarter results could be impacted by the annual true-up of certain incurred but not recognized liabilities. We are considering the next-gen purchase announced last week to be akin to M&A, and we will exclude the Q3 related expenses from adjusted EPS. We continue to expect our fourth quarter to be our best performing quarter. Let me now turn to the second quarter in greater detail. Our 7% year-over-year revenue increase was comprised of FCD's and FPD's growth rates of 9% and 6%, respectively. The increase was also driven by both our original equipment and aftermarket activities, with revenue increases of 9% and 5%, respectively. All regions also contributed to the top line improvement with notable year-over-year percentage improvements in Latin America, the Middle East and Africa and Europe of 13%, 11% and 7%, respectively. Shifting to margins. We generated adjusted gross margins of 32.3%, representing a 200 basis point increase year-over-year and 60 basis points sequentially. As Scott mentioned, our improvement was largely driven by our operational excellence program, solid execution and top line leverage. We expect this, in combination with our product management efforts will expand margins even further as we progress towards our 2027 target level. By segment, FPD's adjusted gross margin of 32.9% was a 300 basis point year-over-year improvement. This progress is encouraging, especially considering a nearly 6% increase in generally lower-margin original equipment revenue. FCD also improved their adjusted gross margin to 30.6%, a sequential improvement of 140 basis points. For the first half of the year, FCD's gross margin was impacted by product mix. So we are pleased to see the quarter-over-quarter improvement. We believe FCD's margins will improve substantially in the second half of the year due to improved product mix and more effective demand planning at facilities. On a reported basis, second quarter consolidated gross margins increased by 170 basis points to 31.6%, despite net adjusted items within cost of sales increasing by $2.6 billion versus prior year. Second quarter SG&A increased $17 million year-over-year to $236 million. Despite this dollar increase, adjusted SG&A as a percent of sales was up modestly 20 basis points to 20.4% driven by solid top line growth during the quarter and our ongoing cost discipline actions. On a reported basis, second quarter SG&A increased by about $9 million, primarily due to a lower level of adjusted items. At 20.6% of sales, SG&A actually decreased by 70 points versus the comparable period. Our adjusted operating income in the quarter was $144 million, an increase of nearly $32 million year-over-year. Our robust adjusted operating margin of 12.5% was a 210 basis point expansion and delivered an exceptional incremental margin exceeding 41% year-over-year. As we indicated earlier in the year, we expect our 2024 performance to be a margin-first story, driven by improvements from our new operating model and discrete actions we're taking, combined with revenue leverage. We expect that as we continue to perform, we will be well positioned to achieve our 2027 adjusted operating margin target of 14% to 16%. By segment, FPD delivered a very strong adjusted operating margin of 16.9%, representing a 370 basis points and 200 basis points year-over-year and sequential improvement, respectively. FCD also increased its adjusted operating margin to 13.4%, which was up 230 basis points on a sequential basis. We also expect to see continued adjusted operating margin expansion in FCD during the second half of the year, primarily as a result of higher gross margins from operational efficiencies. On a reported basis, second quarter operating margins increased 160 basis points year-over-year to 10.5%, driven by our operating leverage and higher realized margins, despite the $7 million increase in adjusted items. Our second quarter adjusted and reported tax rates were approximately 21.3% and 23.8%, respectively. This quarter's reported tax rate was elevated considering the loss on sale of [NASS] and no associated tax benefit. We now expect the full year 2024 adjusted tax rate of around 21% higher than a year ago when we saw the release of discrete valuation allowances in certain jurisdictions. Turning now to cash flow. After six consecutive quarters of consistent cash generation from operations, the second quarter was an operating cash use of $13 million, driven by working capital requirements, primarily in accounts receivable and accrued liabilities. Our receivables increased as a result of the timing of this quarter's strong revenue performance, which was partially offset by an over $27 million sequential reduction in inventory, including net contract assets. Additionally, as expected and in line with previous practice, we paid our 2023 performance based incentive compensation this quarter impacting the accrued liabilities account. As a percent of sales, we saw our second quarter adjusted primary working capital become more efficient and decreased by 260 basis points year-over-year, as the 7% top line growth outpaced the 4% increase in our adjusted primary working capital accounts. On a sequential basis, this ratio increased a modest 90 basis points to 29.3%. For the remainder of the year, we expect our cash generation generated from operations to accelerate. As such, we anticipate our free cash flow generation to adjusted net income conversion rate of around 80% or more for the full year. Other uses of cash during the quarter included $71 million for dividends, capital expenditures and a term loan reduction and share repurchases. Through the first half of the year, we repurchased about 340,000 shares of our common stock for a little over $60 million in addition to returning $55 million in dividends to shareholders. As we execute our capital allocation commitments we announced last fall. As I referenced earlier, last week, we announced the acquisition of in-process LNG pump technology, which we believe will further accelerate our 3D strategy. This transaction exemplifies our capital allocation approach. Our inorganic pipeline is robust, and we remain interested in targets that will drive long-term returns and enhance our 3D strategy. We will remain disciplined with our capital allocation, and we believe our framework will guide us to direct our investment dollars to the highest return and long-term returns for our shareholders. In summary, while we are proud of the results we delivered this quarter and through the first half of the year, we continue to see opportunities to expand margins and earnings during the rest of the year. We also remain confident in our progress and ability to achieve our 2027 goals. Let me now return the call to Scott. Scott Rowe: Great. Thank you, Amy. I would now like to provide an update on our R&D activities across the LNG and hydrogen end markets that support our decarbonization growth strategy. In the third quarter of 2022, we acquired Chart Industries (NYSE:GTLS) in-process hydrogen distribution pumping technology. We were able to commercialize the technology last year, and we are now receiving ongoing orders for the pumps. Our technology enables safe and reliable hydrogen fueling. In the second quarter, we booked $7.5 million related to the construction of 10 new fueling stations in the United States. We're excited about the opportunity to support the expansion of this green fuel source. Additionally, we believe the technology that we developed for hydrogen fueling can be used in other cryogenic gas applications. Last week, we announced the purchase of in-process R&D for submerged cryogenic pumps for liquid natural gas from a start-up company called NextGen Cryogenic Solutions. Flowserve has a significant presence in LNG across our pump, valve and mechanical seal portfolio, but we were missing the submerged cryogenic pump offering, which sits at the heart of the liquefaction and regasification processes. This acquisition from NextGen fills this gap with differentiated technology in a technically difficult space. We expect to fully commercialize our first variation of these pumps in the second half of the year, and we expect to generate bookings in 2025. We remain excited about the growth of LNG and we believe we will capture additional market share with a more comprehensive suite of pump products. In summary, we have made great progress to enhance our product portfolio through small technology acquisitions that built on our flow control competence and domain expertise. Diversification also remains an important part of the 3D strategy, and we continue to drive growth through enhanced focus, improved channel strategy and new product development. Our diversified bookings grew sequentially again in the second quarter, and we continue to apply our portfolio into end markets that present an above-average growth profile. During the quarter, we were awarded a contract from a major global chemical company to supply pumps and valves in the construction of a new commercial scale molecular recycling facility in Germany. This facility will convert over 50,000 tons of plastic waste annually into new polymers for use as feedstock into food safety, healthcare and other diverse industries. Lastly, on digitize, our ability to instrument our products with our Red Raven IoT offering positions Flowserve to provide true solutions for our customers through monitoring and predictive analytics, but also ensuring that we are in the best position possible to provide aftermarket services and solutions for these customers. In the second quarter, Red Raven helped one of our customers save millions of dollars by minimizing production downtime. Our predictive analytics notified our customer of an unstable operating condition in their process and advise them to promptly modify the dry vacuum system operating parameters. As a result, we were able to help our customers avoid significant unplanned downtime that would have cost an estimated $1 million per day in lost revenue. Examples like this increasingly demonstrate the value of our digital capabilities and the possibility of providing solutions to drive flow loop optimization. The Flowserve dry vacuum pump offering is now available and ready to be shipped Red Raven compatible. In conclusion, Flowserve is well positioned for another strong year of financial and operating performance, which supports our second increase to our full year 2024 adjusted EPS guidance. We are confident in the macro backdrop of our served industries as well as in our ability to capture both the run rate business and large project orders under our disciplined bidding approach. We are executing well, and we are excited by the opportunities ahead of us. We are confident in our ability to deliver at least 200 basis points of full year operating margin improvement in 2024 versus the prior year, primarily through our operational excellence efforts as well as the early benefits from our product excellence program. Lastly, we believe we are ahead on the journey to our long-term goals that we communicated at our September Analyst Day last year. Our near-term focus is to further build upon our operational momentum and continue to enhance our margins with operational and product excellence initiatives. We remain committed to our 3D strategy to deliver growth and catalyze on the macro drivers that exist today. We are pleased with our progress in the first half of the year, confident in our ability to build upon the success and are increasingly optimistic about our outlook. We remain committed to further capitalizing on the growth opportunities in the market today, and into the future that will deliver long-term value creation for our customers, our associates and our shareholders. Operator, this concludes our prepared remarks, and we would now like to open the call to questions. Operator: [Operator Instructions] And we'll go to Mike Halloran with Baird. Mike Halloran: Let me just talk through the thought process in the second half of the year here and what it means for next year. So certainly understanding these comments that you've been talking about the last few quarters about how the seasonality is a little bit more level relative to history. Could you just give some more context there? And then more specifically, talk to some of the margin moves. It feels like there's some conservatism embedded in the margins in the back half, but I want to make sure I understand how the mix is moving around between aftermarket OE or any other variables that might hit that? Scott Rowe: Sure. I'll let Amy start and then I'll probably add a few comments. Go ahead, Amy. Amy Schwetz: Sure. I'll start with revenue. And I think as we've entered into 2024, we are coming off a year with really strong revenue growth. We knew that this was going to be a year about margin expansion rather than outsized revenue growth. And so you're seeing that play out in 2024. The first and second quarter up against easier comps, I would say, are supporting really nice revenue growth, and we'll see that moderate in the back half of the year. As we think about how this plays out into 2025. These large projects that we booked in Q2 are really going to be a 2025 revenue story versus a 2024. And so although we see those growth rates moderating, we think that we are building the type of backlog that positions us well going into 2025. And then I'll just comment overall that the internal messaging and push is really around leaning into growth in the second half of the year. So continuing to do what we've done, particularly around those higher-margin pieces of the business and you see that coming through in our aftermarket bookings in the second quarter at the level above $610 million. From a margin expansion perspective, we're really pleased with how we've moved through the second half of the -- or the first half of the year. And I'll comment specifically on FPD, which we really thought had an outstanding quarter from a margin expansion perspective. There was nothing special in there, Mike, but it was a well-executed quarter. So we saw mix shifting slightly favorably for us with the ability to drive aftermarket revenue slightly higher than we expected based on the strength of those bookings. And then our project revenue actually shifted a bit towards higher-margin projects that we see. So although I don't want to call that 16.9% operating margin as the new normal, I think you will definitely see Q1 margins as the low watermark. And so I would expect for the rest of the year that we'll deliver at sort of a 15.5% operating margins or better in the back half of the year, as we continue to really lean into operational excellence and growing the profitable pieces of that business within FPD. From an FCD perspective, we performed a little bit better than we thought we would in the second quarter of this year and that was driven in part by operational execution. It was driven in part by a slightly more favorable mix than we anticipated with more services and solutions revenue in the quarter than we'd expected when we began. That said, we still see room for further margin expansion in the back half of the year. That's driven partially by mix and more sort of automation and control valve type work, less project type work. But more importantly, by operational efficiencies we see coming through in the back half of the year. So bottom line margins this year are progressing nicely. The 12.5% that we saw this quarter was very strong, but we see the opportunity, as we've indicated to grow operating margins by 150 basis points or more in 2024. Scott Rowe: And then maybe the only thing I'll add would be that we've worked really hard to minimize the variability between Q1 and Q4. The last two years, we've come out really strong in the first quarter of the year, including this year. And so that seasonality will still play out. The Q1 will be the lowest of the year for us. Q4 will still be the highest. But the variability between those quarters will be much smaller and we'll continue to work to close that gap. Mike Halloran: So second question, Scott, you were talking about a more formal product line review launch, so a couple of questions related to that. One, was that embedded in the expectations you laid out at the Analyst Day? And two, maybe just a little bit more color, and I know you only launched on one, you're broadening it out. But a little more color on what you're seeing or early feedback of what the magnitude of the opportunity might look like and how that could be prioritize your time and capital internally? Scott Rowe: Yes, absolutely. And so at the Analyst Day, we laid out kind of two big growth levers. One was operational excellence, where we committed 100 basis points to 200 basis points improvement and I'll just start there. That's gone incredibly well. We're seeing that in the results this year and we continue to see further upside to operational excellence. And then on the product excellence, we also committed to 100 basis points to 200 basis points of margin improvement. And within product excellence, we talked about two categories. One was product management and one was portfolio optimization. And so last year, at the beginning of the year, when we did our reorganization, we recommitted I will say, to really driving product excellence with a dedicated product management organization. And so that essentially unlock this capability to really review our product families and product portfolios in a much more robust fashion within each of the seven business units. And so the exercise that we kicked off at the beginning of this year in the first business unit is really on the product optimization. And so looking at the different product families within a business unit, understanding what we really like from a margin standpoint, a product SKU standpoint and a customer standpoint, and then taking decisive actions to either invest in products, move products out, raise prices and do all the things that we need to do to maximize the ability to generate value within those product families. And so the first business unit has been kind of in flight now for about four to five months. We've got clear visibility to the actions and margin improvement and what I'm really excited about is we believe we can move the margins up while continuing to drive focus on growth. And so we don't think we compromise growth with this program, but drive margins up substantially. And so we've got one business unit in flight. We'll launch the second business unit. We've already done all of the data analysis. We'll launch that next month in terms of starting to develop that action plan. And then we've got the third business unit going in flight by the end of the year. So in summary, we're excited about product excellence. We're still committed to 100 basis points and 200 basis points from the product excellence initiative. And I would say we haven't really seen the benefit of that year-to-date. And so that starts to show up at the end of this year but more predominantly into 2025. And then ultimately, that will continue into 2026 as well. Operator: [Operator Instructions] And we'll move next to Joe Giordano with TD Cowen. Joe Giordano: Can you talk about like where the jumping off point from 4Q, right? So the margins of 4Q would be your best quarter. You talked about compressing this. So this -- how do you see that as like compared to it early and early thoughts on margin for '25? It's been a pretty big jump down each year. It's getting less, but like I just want to like bring this appropriately for people as we kind of set new expectations from here? Amy Schwetz: Yes. So I think, Joe, as we look at finishing up 2024 and kind of moving into 2025, we're going to be focused on the things that we've been focused on the last two years. So really minimizing that differential between Q4 and Q1 and using that exit rate from an OI perspective to really drive performance in that coming year. That said, I don't think that we've fully solved the seasonality issue, particularly as a business that's looking to grow revenue. So I think that we'll continue to see 20 -- the first quarter of the year. We are lightest from both a revenue and an earnings perspective, as we move forward. But as we look at the phasing of some of these larger projects, we'll continue to focus on how do we manage that top line revenue in a way that really maximizes earnings, but also helps us on our working capital journey as well, which the more steady levels of revenue certainly helps with. Scott Rowe: So I will just add, we're on this progression to the targets we laid out in -- for 2027 last year at the Analyst Day. And so everything we're doing is geared to driving towards the 14% to 16%. We made great progress this year. And so I'd say, while first quarter next year will come down slightly the full year, we should see another substantial step toward achieving these targets. Amy Schwetz: Yes, absolutely. I think Scott's kind of laid out the road map in terms of how we see that with continued work on operational excellence, where we feel like we've done a lot of work and we're seeing it at the gross margin level, but with product excellence, really, really kicking in, in 2025 and providing us an opportunity to expand margins and get us even closer to our long-term target. Joe Giordano: And then it was interesting to see like the targeted divestment there in the quarter. Are there more opportunities for stuff like that? Like how much of your portfolio do you feel like you've analyzed with that sort of lens at this point? Amy Schwetz: We're going to continue to look through that. And some of the data analysis that Scott referenced is going to continue to help us do this. This was a relatively easy call for us to make. It allowed us to reduce our footprint, it was dilutive to earnings and it was something that once we found the right buyer it was easy for us to make that call. We're going to continue to look for those opportunities, although this was one that was probably a little bit easier than others might be as we continue to get better at both product management and portfolio optimization. Operator: [Operator Instructions] And we'll take our next question from Andy Kaplowitz with Citigroup. Andy Kaplowitz: Scott, so you mentioned the bookings pipeline for Flowserve is up 8%, I think. So maybe you could elaborate on that pipeline. Do you still see other large projects out there in addition to what you booked last quarter? And then do you think book-to-bill can still average over 1 over the next few quarters or at least in the second half of this year? Scott Rowe: Sure. Yes. In the prepared remarks, we did say the project funnel is up 8% year-over-year, giving us really good visibility to project work. And when we talk about the project funnel, it really is projects greater than kind of $5 million. And so we're talking about the larger type projects. Q2 obviously was really good. We had three very large projects in there. I don't see another incredibly large kind of near that $100 million mark in the near-term funnel. But we have a long list of opportunities, let's just call it, kind of $25 million to $50 plus million. And where we see those opportunities, we've got primarily Middle East. And so there's still a lot of activity in the Middle East, Saudi, UAE, Qatar. We've got some work that we've got visibility to in Oman, in Kuwait and so there's a substantial build out there of gas processing and then further downstream activities like refining and petrochemical. And so our outlook there is incredibly positive. On the power side, we saw our funnel up 22%. That's on the forward look one year out. And so a lot of that activity is around nuclear. And we've got very strong visibility to nuclear build-out in Europe and parts of North America as well. And so, we're pretty excited about the power outlook. And then on the energy transition funnel, it's up 40% year-over-year and kind of that new energy and energy transition for us is the fastest-growing end market. And while the projects aren't in the super large size of kind of greater than $50 million, we do see very robust project activity within energy transition funnel. And so the average size of that would be anywhere between $5 million and $20 million. So long story short, the funnel is up. We've got good visibility. We believe the full year book-to-bill is greater than 1, which implies kind of a second half of the year at over 1 as well. And I think that given the project outlook in some of the mega trends that we're following, we feel pretty good about certainly, our visibility through the end of the year but into 2025 and 2026 as well. Andy Kaplowitz: And then can you talk about the return on investment that you expect from the new cryo pump acquisition that you made in LNG, at least versus that $0.05 that you're going to take that you talked about last week in the release, do you see sort of an immediate return in the form potentially more significant wins in LNG, either here in the second half of '24 or '25. How do you -- how should we think about the returns? Scott Rowe: Yes. I'll talk about kind of our outlook there and then maybe Amy can talk about our returns profile against some of the other acquisitions and things that we look at from a capital allocation standpoint. But on the LNG side, we're very excited about LNG as kind of this transition fuel. It's not going away anytime soon. And with our pumps, valves and mechanical sealing offering, we get all -- we get a front row seat to all of the projects and the aftermarket activity. And when we looked at the portfolio of what we can provide within LNG, what we were missing was the submersible cryogenic pump, and it truly is the heart of the process for both the regasification side and the liquefaction side. So this is something that's been on the product development side for years at Flowserve. It's been something that we wanted to do. And what we found was kind of a creative path to acquire the in-process R&D or the license and technology of the cryogenic pump. And so we've got some further product development work to do through the end of the year. But we've got a clear path to doing those prototypes and the testing before end of the year and beginning to commercialize the product into next year. We think submersible cryogenic pumps is at least $250 million a year of kind of new equipment, but our pump can also be retrofitted into existing facilities. And so we're actually really excited about the opportunity to put our pump into existing applications that we were not -- we didn't participate in because we didn't have that product. And so this is something that we can easily see a $50 million a year of kind of revenue, maybe not next year, but certainly into 2026 and 2027 and we're excited about the growth of this product. Amy Schwetz: And just from a return standpoint, we would look at this through the lens of likely would any sort of inorganic growth. So does it fit the strategy, which Scott's clearly outlined, is it accretive to margins? We believe it will be. And then are the long-term returns there. The one comment that I would make is something like this that we need to commercialize, we would actually expect slightly -- well, we would expect higher returns than we would on an existing business that may have less risk in terms of that commercialization period. So we're really excited about the potential returns that are out there. And in this instance, we are able to finish the acquisition of this in a way that actually sort of limits the risk going forward in terms of commercialization. So something we're very excited about. And then the last comment that I would make is what we've not included in the economics of a transaction like this is the ability for this product to help us lead pull-through of other Flowserve products into LNG facilities, which is an added benefit, we believe it may provide longer term. Operator: We'll go next to the line of Deane Dray with RBC Capital Markets. Deane Dray: Scott, I'm always interested in hearing your take on the composition of the orders in the quarter. You highlighted the three large ones. But just looking deeper into that order book, what's your take in terms of the size and what that means? And then can you also give some color on the record aftermarket, is that the installed base coming through? Or are you doing something extra in terms of getting your access to those aftermarket orders? Scott Rowe: Sure. I'll start with projects and then I'll talk about aftermarket and quite frankly, after a market was the highlight. So I'll spend a little more time on that. On the project side, we had three large orders, roughly $200 million across all three of those. They're in the Middle East, mostly around gas processing but also a chemical award. And again, we've got incredibly strong connections in the Middle East. We have a strong presence with the ability to make pumps, valves and seals in the Middle East, and then we've got an amazing team that's doing a good job with the end users there. We've got continued outlook and visibility to projects in the Middle East, and we're confident in our ability to continue to drive that business forward. When you get beyond those three awards, we did have a long list of project awards in kind of the $5 million to $15 million range. We had significant power bookings $70 million plus on the nuclear side. We had a lot of energy transition type work. And so a really nice balance across industries within the project bookings. But let me turn to aftermarket. We booked $614 million in the quarter. That's the highest level of aftermarket bookings we've ever had. It's the seventh consecutive quarter now over $550 million work. And I'd say there's two big drivers here. One, on the market side. Clearly, high utilizations across where our installed base is, so refining plants -- petrochemical plants, chemical facilities, power facilities, all running at reasonably high utilization levels, which is driving parts and service on our side. There's also some pent-up demand just -- I don't know if it's the COVID side, but just some deferred maintenance that's still coming through the system. And so that's helping us as well. But I'd say the second big driver for us was -- is really on the back of our new ore design last year, where we clearly segmented services and solutions in the pumps division and we segmented in a separate BU within our valve business. And so what we've seen by this enhanced focus is our ability to move up our capture rate on our installed base. And so through deliberate actions around quoting quicker, providing shorter lead times being more responsive in general, the mantra, quite frankly, is speed wins in our aftermarket business and so what we're seeing is our capture rates continue to move up within the aftermarket business. And so if we look forward, obviously, record bookings at $614 million in Q2. But we believe that we can continue to move this up. Our capture rates still have opportunity for improvement as we continue to drive speed in all aspects of the aftermarket business. We believe that we can continue to grow this side of the aftermarket side of our business. And so we're excited about what the teams have done. The new org design is, quite frankly, is unlocked some of this capability and provided more of a global perspective across both valves and pumps, and we believe we can continue to drive initiatives that lead to enhanced growth within the aftermarket business. Deane Dray: That's exactly what I was looking for in terms of what was the drivers around the capture rate. And then second question, nuclear has come up a handful of times. You talked about opportunities and some activity in Europe and North America. Is there anything that you've seen so far related to power needs for data centers. That's -- we're hearing a lot more of that as an opportunity as Amazon (NASDAQ:AMZN) making an investment in a nuclear plant. Anything on the small modular reactor side? And what are your opportunities? Scott Rowe: Sure. I'll start power and general, I'll go to nuclear. I'll end with SMRs or small module reactors. So power outlook for us is we feel pretty good about what we're seeing there. I'm laughing because last year at our Analyst Day, we committed to -- was at 3.2%, Jay. We committed to 3.2% on the forward look. Clearly, we were understated there and missed some of the trends on the data center and AI. We'll put out some kind of new work on what we see that growth rate is. But power for us is a $400 plus million business a year. We're in pretty much all of the power applications, whether it's coal-fired power plants, whether it's natural gas, nuclear, everything else. So we have a massive installed base. And what we believe over the next couple of years is an inflection to increased power demand, both in the Americas and in Europe. Ultimately, we see that across other parts of the world. But after decades of power demand being relatively stable, we're now seeing, what I'll call, reasonably substantial growth and that growth is driven on the back of everything being electrified and this new kind of data center demand driven on the back of artificial intelligence. And so we feel that the outlook in power is substantial. We see existing power generation facilities, we see the utilization rates start to increase. We're seeing plans for expansions and capability or increases in generation within the U.S. And then we're also seeing substantial build-out across Europe and other parts of -- well, India and other parts of Asia Pacific as well. And so we're excited about what we can do in power. We've got a pretty good lineup of products across pumps, valves and seals that supports traditional power and nuclear. Then on the nuclear side, we believe that this is an area to provide incredibly clean and reliable and safe fuel regardless of any condition. What we're seeing is expansions in Europe, primarily on the back of EDF (EPA:EDF), the French nuclear authority that has the license for a lot of different nuclear applications in Europe, and they're moving into India as well. We've got strong relations with them on both our pumps and valve portfolio. And we're pretty excited about their plans as they go forward and pulling our product into their expansions. And then also in Europe and certainly in the Americas, what we're seeing is life extensions on existing nuclear assets. And so they're taking the existing life of that asset and adding a 20 or 30 year life extension to the nuclear facility and when they do that, it's a substantial aftermarket effort on our side to rerate pumps and valves and replace a lot of the existing equipment to make sure that our equipment is working for the full life of that extension that they've defined. And so overall, we see nuclear generation as something that will continue to grow. It doesn't happen fast, but we are now seeing substantial signs in our forward funnel of significant growth as we go forward. The power funnel overall is up 22% year-on-year. Our nuclear funnel is kind of right at that 20 plus percent a year. And so I think you can expect us to talk about nuclear for many quarters to come as we go forward. And then on the last question with small modular reactors. We are participating in several of the kind of the R&D or the technology development to support SMRs, but my view is that's still many years away until we get to a commercialized product and that becomes a meaningful part of our business. So what we're doing is we're working with a very select few players that we believe we're in an advantaged position with their technology. And our hopes are that by working with them, we'll get our pumps and valves spec into their process. But again, I'm not optimistic on the time line, that's probably still kind of 5 to 10 years out until it's commercialized. Amy Schwetz: One comment I'll just add into that is that the hype is happening. So the first half of the year, we've seen a 20% increase in power bookings year-over-year. So this is not just a trend that we see playing out in the future, it really started in the first half of the year. Operator: We go next to the line of Damian Karas with UBS. Damian Karas: I'm hopping on late from another call. So probably, if you touched on it, but I didn't hear anything about price. So I was wondering if you could maybe just give us some perspective on the pricing environment you're seeing. How much are you realizing to date? And in terms of the funnel, the order, the bookings, are you still kind of seeing some incremental value from kind of that value-added pricing or is that mostly normalized? Scott Rowe: Sure. I'd say we're in a much better place than we've been in the last two years, and I'm happy that this hasn't been the first question out of the gate. But I'd say we're doing a much better job on pricing. Our cost inflation has moderated or subside in many parts of our business. We did announce the price increase at the beginning of the year, roughly kind of what I'll call more normal price increase in that 4% to 5% and we believe that we're doing a much better job kind of realizing that price increase, making sure that it sticks and making sure that we're on the positive side of the price/cost curve. And so that would be for our general business. The mechanical seals are kind of run rate valve business and then the more industrial-type pumps. And then on project pricing, we've talked last quarter and even the quarter before about our selective bidding and making sure that we get the margins that we deserve for large complex projects. And what I would say is that our team has done a really, really good job working through a very complicated landscape with EPC and end users, but we're really making sure that we can deliver the price and the margins that we think are acceptable for some of the risks that we take on in the larger projects. And I'd say the overall project pricing environment has gotten better. It's still not perfect, but it's allowing us to continue to walk up our project pricing. And so overall pricing environment has improved substantially from a year ago. We continue to see this as constructive as we move into the back half of the year and into 2025. And then I'd just say as part of the product excellence initiative, pricing is a big component there. And I think what you'll see over the next year or so is that we get a lot more disciplined on pricing. We'll be more specific in product families and customers on pricing and so just a more mature approach to pricing as we kind of roll out the product excellence initiative. Damian Karas: And then you called out the 3D bookings growth above 25%. So I'm kind of curious on the 3D. Maybe you could just give us an update on Red Raven, how the adoption is tracking? Any updated views on what you think is possible there? Scott Rowe: Sure. Yes. We continue to make really solid progress here. I do wish it was faster. We're up to kind of 2,250 assets that we've now instrumented. What I would say on a very positive note is the system is working incredibly well. The customer feedback is really high. And what we're finding is when we do instrument pumps or valves within a customer facility, we typically get repeat orders or asking to kind of add more assets to our monitoring program and our prediction. And then the other thing I'd say is the algorithms that we developed, it's been almost kind of five years now. They continue to get better with all of the data that we're collecting and what we're finding is that the system is doing a really good job on predictive analytics and allowing our customers to avoid unplanned downtime. So in my prepared remarks, we talked about this happening with a dry vacuum product, where we saved the customer $1 million a day of potential lost revenue because we're able to alert them to a process condition that they weren't aware of through their traditional DCS system. And so I'm still very excited about this. I do think if we fast forward 10 to 20 years, I think most, if not all, full control will be instrumented. So I feel like we're doing the right things. I also feel like we're at an inflection point in terms of Red Raven adoption. We've got some great case studies now, and I think we'll see this growth rate pick up even more than what it is. And then finally, I'll just say we believe that the digital side, the ability to instrument our equipment, the ability to understand kind of flow conditions and provide these predictive analytics truly allows us to be a much better solutions provider when it comes to full control. And so when we add this system to a facility, we become very close with the operating team, and it allows us to pull through parts and incremental services. And so we're already seeing a tremendous benefit on our aftermarket when we do have Red Raven installed at sites. And so we're going to keep focusing on this. I expect the inflection rate to come up, and I do expect us to talk more and more about our ability to generate solutions within a full-loop environment. Operator: We'll go next to the line of Nathan Jones with Stifel. Nathan Jones: I wanted to go back to gross margins. I guess the first question here is, if I look back at 2019, you had gross margins heading in the right direction at that point. And then obviously, COVID derailed everything. And we saw compression from there. In '23-'24, you're back to a point where revenue is higher than it was in 2019, but gross margins are still 100 basis points or so lower. Can you talk about what the difference is in the business today versus five years ago that still has gross margins slightly below where they were in 2019 on higher revenue? Amy Schwetz: So I'll start with -- I mean, we think that we can get back there, Nathan. And so I appreciate the question in terms of how we're thinking through the operating margin expansion that we've got embedded in our long-term targets. So we've talked this year about expanding gross margins 150 basis points or I'm sorry, expanding operating margins by more than 150 basis points. As you can see in Q2, the majority of that is coming from gross margin expansion. And so we believe that the levers that we've outlined in terms of operational excellence, which is already showing dividends and product excellence can work to further expand those margins and get us back to those 2019 levels or, frankly, higher than that as we move forward. The one thing that I would point out with respect to 2019 is operating margins in 2019 were 11.3% versus the 12.5% that we saw in the second quarter of this year. So I believe we'll end 2024 at an operating margin higher than what we saw in 2019, which frankly puts us on solid footing to continue to deliver value to our shareholders both via gross margin expansion and cost control within other cost categories to make the company stronger than what we've seen in those previous years. Nathan Jones: I guess the follow-up then is going to be gross margin. Just specifically on FCD, because if you look back historically, that's where gross margins have typically been higher. FPD is actually kind of back to where it has been historically on gross margins, but FCD is the one lagging. So can you maybe talk about if there's something structural that's changed in the business? You used to be able to kind of get towards mid-30s gross margins for FCD. And if there's nothing that structurally changed, what's the path to getting that business back to mid-30s gross margin? Amy Schwetz: Yes. So I would say our long-term targets for FCD from an operating margin perspective, we're a little bit lighter than where we've seen that historically. And that is due to a mix shift in that business, both in industry, but in the balance that we're providing. So more of a focus on really the isolation valve piece of the business, and we want to continue to grow our ACV, our automation business, but isolation balance have been growing a little bit faster. So that mix has been impacting us. And I'll just comment as we talk about power generation, that is isolation valves that are driving some of that growth that we see over time. That said, we see a tremendous opportunity for growth in the valve business moving forward. And frankly, FPD, we're not stopping on margin expansion, but we're at our long-term targets in the second quarter in terms of operating margins. So what do we need to do with FPD. The start is in the second half of the year, the operational excellence and execution will get better. We'll see that kick in, in a bigger way than what we've seen in the first half of the year. And as Scott pointed out, product excellence is really going to be a 2025 story, but that journey starts this next quarter for our valves business. So we're confident that those margins will be expanding not just in the back half of the year, but as we move into 2025. Operator: We go next to Brett Linzey with Mizuho. Erick Look: This is Eric Look on for Brett Linzey. Focusing on Asia-Pacific, it's nice to see a tick up 5%, improving from last quarter's 1% growth. How should we think about China's contribution to the region in terms of sales and bookings and maybe some color on Asia-Pacific outside of China as well? Scott Rowe: Sure. Within China, we've got two large facilities that essentially do China for China, both on the pump side and the FCD side. And so we feel like we're reasonably well positioned there. I would say, at this point, we're not investing in China, but those teams are clearly geared towards winning projects within China and then I'd say probably more importantly, capturing the aftermarket within our installed base. And so, I'd say that's kind of the focus area for China at this point. And then broader Asia-Pacific, when we look at that year-over-year, we look at it even compared to years ago. That business is slightly down. I'd say it's the investment across Asia-Pacific is a little lower than what we would expect. But I do still -- I believe that there is optimism in terms of projects and run rate increases, as we kind of move forward into 2025 and 2026. And so well represented in Greater Asia-Pacific. We've got teams in most countries. And I think we've got an amazing installed base. And so the aftermarket business continues to perform reasonably well, but we haven't seen the project business like we expect. And so again, I think on the forward look, I think it comes up from here. But the China growth and commitment is not where we're going to put our focus and efforts in the foreseeable future. Operator: We'll take our final question today from Joe Ritchie with Goldman Sachs (NYSE:GS). Joe Ritchie: So Scott, your comments on the aftermarket business for like super positive. And I'm kind of trying to think through this beyond 2024. And so is it right to consider $600 million is kind of like the new quarterly run rate, and that's something that we should basically capitalized into next year? Or just any thoughts around the sustainability of the current orders and how that translates into revenue going forward? Scott Rowe: Sure. Like I said, we haven't seen anything crazy here or one-off or anything that's like juicing the bookings in the second quarter. And what we've seen, if you kind of projected this out over the last 18 months quarter-over-quarter, what we've seen is just nice, steady progression here. And again, I think there's a market element to this with higher utilization rates, a little bit of pent-up demand but not a ton. We did have spring turnarounds. And so there was an uplift in the second quarter around that. But I'd say overall, the market activity should continue as we look into the forward quarters here. And then secondly and probably the biggest driver is the new organization design creating enhanced focus on both pumps and our valve business to really make sure that we're winning our entitlement here. And so we have a massive installed base of pumps and valves around the world. We do track our capture rate, our ability to get the aftermarket on that installed base and I'd just say there's lots of room for improvement on moving this capture rate up. And with all of the initiatives around being more responsive, quoting quickly, shorter lead times, what we're seeing is those capture rates move up. And so, I think this is sustainable. We may tick down a little bit maybe in the third quarter or something as we look forward. But I'd say that overall trend in growth rates should continue at a nice steady progressive rate as we go forward. Joe Ritchie: And then my one follow-up for Amy. Just on free cash flow for the quarter was a tad bit lighter, but I know that there's sometimes timing issues. It seems like receivables uptick this quarter. So is it right to just kind of think about that as a timing issue? And then what are just your expectations for free cash flow for the year? Amy Schwetz: Yes, absolutely. So we knew that Q2 was going to be a challenge from a free cash flow perspective. The accounts receivable build we saw was not as a result of any collection issues but more timing related in terms of when those products went out the door when we hit milestones on percentage of completion projects. So we think we're set up for a really strong second half from a cash flow generation standpoint. And in fact, really picked up our guidance a little bit on our first half results. So we were previously anticipating kind of 70% to 80% free cash flow conversion in the year. And we're now thinking more of some level of 80% or better for the full year. So it points to a really strong cash flow generation in the second half of the year as we collect on the strong revenue conversion that we've had in the first half of the year and expect in the second half and importantly, continue to make progress with respect to inventory management. So we're excited about where we're going, both with primary working capital management and free cash flow generation more broadly. Operator: This concludes today's conference. We thank you for your participation. You may disconnect your lines at this time.

Flowserve Corporation (FLS) Q2 2024 Earnings Call Transcript

Jay Roueche - Vice President, Treasurer and Investor Relations Scott Rowe - President and Chief Executive Officer Amy Schwetz - Senior Vice President and Chief Financial Officer Good day, and welcome to the Second Quarter 2024 Flowserve Corporation Earnings Conference Call. Today's conference is being recorded. At this time, I'd like to turn the conference over to Jay Roueche, Vice President, Treasurer and Investor Relations. Please go ahead. Jay Roueche Thank you, Melinda, and good morning, everyone. We appreciate you joining our conference call today to discuss Flowserve's second quarter 2024 financial results. On the call with me today are Scott Rowe, Flowserve's President and Chief Executive Officer; and Amy Schwetz, Senior Vice President and Chief Financial Officer. Following our prepared comments, we will open the call for your questions. As a reminder, this event is being webcast and an audio replay will be available. Please note that our earnings materials do, and this call will, include non-GAAP measures and contain forward-looking statements. These statements are based upon forecasts, expectations and other information available to management as of July 30, 2024, and they involve risks and uncertainties, many of which are beyond the company's control. We encourage you to review our safe harbor disclosures as well as the reconciliation of our non-GAAP measures to our reported results, both of which are included in our press release and earnings presentation, and both are accessible on our website in the Investors section. I would now like to turn the call over to Scott Rowe, Flowserve's President and Chief Executive Officer, for his prepared comments. Scott Rowe Thanks, Jay, and good morning, everyone. We delivered another quarter of strong results with sequential and year-over-year improvements driven by outstanding execution. Compared to the second quarter last year, some highlights include: revenue growth over 7% with adjusted gross and operating margins increasing to 32.3% and 12.5%, while our adjusted earnings increased more than 40% per share. Our strong bookings of $1.25 billion in the quarter, represents a 12% increase versus last year and sequential growth of 20%. With a book-to-bill of almost 1.08x in the quarter, our backlog grew over $70 million sequentially to $2.7 billion, positioning the company for further growth. I want to thank our associates around the world for their passion and dedication to supporting our customers in delivering these impressive results. Continuing with second quarter commentary. Our adjusted earnings per share was $0.73, representing a sequential increase of $0.15 and $0.21 year-over-year. Our bookings are at the highest level since 2014 and included a healthy mix of project awards with ongoing strength in both MRO and aftermarket activity. We generated over $1.15 billion in revenue and increased our adjusted gross and operating margins by 200 basis points and 210 basis points respectively, versus the prior year, which gives us further confidence in our margin progression journey. We are very pleased with our results and the progress we have made in the last couple of years, as we implement and capitalize on opportunities for growth and further improvement. Our operational excellence program continues to deliver results with significant progress within our manufacturing facilities. The new organizational design, combined with improved process discipline is allowing us to operate at a much higher level. While the recent results are impressive, we are confident that there is further upside as we continue to drive maturity in our operations journey. Additionally, we launched our formal product excellence program earlier this year. We have undergone an extensive product portfolio review within one of our seven business units and have identified significant opportunities to deliver higher margins without compromising our focus on growth. We plan to launch this program with our second business unit next month and a third business unit before the end of the year. As discussed at our Analyst Day last year, we have committed to an incremental 100 basis points to 200 basis points of margin improvement from the product excellence program by 2027. The early progress is encouraging, and we expect to begin to see results from this effort in the back half of 2024 and 2025. Operational and product excellence are essential components of the new Flowserve business system that was created to deliver improved process consistency and financial performance across Flowserve. Let me now turn to bookings in our end markets. Our second quarter bookings of $1.25 billion marks our tenth consecutive quarter with bookings over $1 billion. Our 3D growth strategy represents over 25% of our total bookings again this quarter, reaffirming our strategic approach. Our bookings were balanced in the second quarter with original equipment and aftermarket activities each representing about half of the total. For original equipment, we benefited from three large projects in the Middle East, including the two we announced in April. Together, these large awards totaled approximately $200 million. The elevated asset utilization rate and spring turnaround season at our customers' operations led to record quarterly aftermarket bookings of more than $610 million. In addition, we have now delivered seven consecutive quarters above the $550 million level, showing the resilience of this higher margin, faster turn, parts, service and repair work. Flowserve's local presence, strong customer relationships and high levels of service continue to produce solid capture rates on our vast aftermarket entitlement. We expect the world's existing refining, chemical and power facilities will remain at high utilization levels for the foreseeable future and our aftermarket business is well positioned to service their need for continued operability. By end market, oil and gas generated the highest level of dollar growth, representing a year-over-year increase of about 22% and includes two of our three large projects we received this quarter. We also continue to capture a substantial number of 3D bookings that are recorded in this end market, primarily in decarbonization activities such as carbon capture, biofuel conversion, LNG and our energy advantage program. We also demonstrated significant growth within the chemicals market this quarter, booking $272 million. This represented 14% growth versus the prior year and was driven by the Emerald greenfield petrochemical project in Saudi Arabia, which was announced in April. We continue to expect significant chemical capacity additions in the Middle East and modest improvement in overall global chemical demand. We are also making good progress with all aspects of the 3D strategy diversifying into specialty chemicals and plastic recycling, decarbonizing existing petrochemical facilities and adding Red Raven to flow control products in both existing and new chemical plants. Last quarter, I highlighted the expectation for increases in power generation, driven by the growth in data center capacity fueled by ever-increasing artificial intelligence activity. Second quarter power bookings were $153 million, which represents a 34% increase year-over-year. Additionally, nuclear activity saw particular strength this quarter with more than $70 million in bookings. We continue to be optimistic about nuclear power generation growth for new projects in light -- life cycle extensions in various parts of the world. Another end market we are seeing encouraging signals is the mining industry. As more rare earth minerals and other mine products are needed for batteries, electrical transmission, energy storage and grid hardening, we see stable long-term growth in this sector. Currently, our efforts in mining are included in our general industries bookings and amount to roughly $100 million a year of activity. We plan to increase our organic efforts in mining to capture a larger portion of this expected growth through enhanced channels to market and further new product development. Additionally, as we evaluate inorganic opportunities to create value for our shareholders, further mining exposure would be one area of interest to help fortify our existing offering and achieve our stated goal of diversifying our portfolio of products and services. Turning now to second quarter bookings by region. We saw strong growth in the Middle East on the back of the three large projects as well as modest growth in the Americas. Europe and Asia-Pacific bookings declined slightly year-over-year. Our overall project funnel is up 8% year-over-year, reflecting the continued visibility into significant project opportunities in the Middle East and other parts of the world. Our traditional short-cycle MRO and aftermarket business has proven quite durable, and we expect to see continued growth on this side of the business. As a result, we believe the macro environment and outlook remains favorable for the full control space. We continue to see positive signals driven by the key global megatrends from energy transition and decarbonization to energy security and regionalization to electrification and digitization. Combined, these current and potential megatrends are attracting significant investments. Flowserve is well positioned to capitalize on these trends and drive further growth. In the second quarter, we grew our backlog sequentially by over $70 million to $2.7 billion, positioning us for continued revenue growth. We expect our full year book-to-bill ratio in 2024 will exceed 1.0x and we are off to a good start to the first half of the year with a book-to-bill ratio of 1.02x. Combining our solid performance for the first half of the year with expectations for continued improvement, we have increased our full year adjusted EPS guidance range for the second time this year to $2.60 to $2.75, which at the midpoint represents a nearly 27% increase year-over-year. We are making significant progress at Flowserve, and we believe we are well on our way to achieving the 2027 financial targets that we communicated at last year's investor event. I will now turn the call over to Amy to address our second quarter results in greater detail. Amy? Amy Schwetz Thanks, Scott, and good morning, everyone. Looking at our financial results in more detail. We generated another quarter of strong sales, nearly $1.2 billion, which combined with improved margins, delivered adjusted earnings per share of $0.73, a 40% increase versus last year. I want to echo Scott in thanking our associates for their continued efforts and execution, which were instrumental in driving both top and bottom line growth during the quarter. Our support of end markets, robust asset utilization by our customers and focused efforts from our sales team led to record quarterly aftermarket bookings of $614 million. Coupled with strong revenue conversion, our operational excellence led margin improvement initiatives and ongoing cost discipline, we generated adjusted operating margins of 12.5%, which represented year-over-year and sequential improvement of 210 basis points and 160 basis points, respectively. With $0.18 of net adjusted items, our reported earnings per share was $0.55. The largest adjusted item was realignment expense, and it was primarily related to our divestiture of the NAF AB control valve business, which principally serves the pulp and paper market. The largely non-cash charge from the divestiture was $13 million or over half the total adjusted amount. The NAF business had modest and cyclical annual revenues and was breakeven at best. This transaction is indicative of how we are optimizing the portfolio by proactively taking action with respect to end markets and products dilutive to the overall business and it's just one example of how we intend to drive further margin improvement across our business. On the strength of our first half results, combined with opportunities we see ahead for the rest of the year, we are narrowing and increasing our full year adjusted earnings guidance range to $2.60 to $2.75 per share. At the new midpoint, this would represent a 27% increase compared to last year's adjusted EPS. To provide context to the phasing of guidance for the balance of the year, we still expect a stronger second half of this year compared to the $1.31 of adjusted EPS we delivered through June 30. Over the past several quarters, we have highlighted steps taken to smooth the quarterly seasonality of our business. And looking ahead, we do expect less differentiation in 2024 than in past years. As you can calculate from our full year revenue guidance, we do expect our year-over-year growth rates to moderate in the second half as we encounter tougher comps. Additionally, while we typically don't provide quantitative EPS, I will say that the third quarter should look operationally very similar to our solid second quarter performance. Our third quarter results could be impacted by the annual true-up of certain incurred but not recognized liabilities. We are considering the next-gen purchase announced last week to be akin to M&A, and we will exclude the Q3 related expenses from adjusted EPS. We continue to expect our fourth quarter to be our best performing quarter. Let me now turn to the second quarter in greater detail. Our 7% year-over-year revenue increase was comprised of FCD's and FPD's growth rates of 9% and 6%, respectively. The increase was also driven by both our original equipment and aftermarket activities, with revenue increases of 9% and 5%, respectively. All regions also contributed to the top line improvement with notable year-over-year percentage improvements in Latin America, the Middle East and Africa and Europe of 13%, 11% and 7%, respectively. Shifting to margins. We generated adjusted gross margins of 32.3%, representing a 200 basis point increase year-over-year and 60 basis points sequentially. As Scott mentioned, our improvement was largely driven by our operational excellence program, solid execution and top line leverage. We expect this, in combination with our product management efforts will expand margins even further as we progress towards our 2027 target level. By segment, FPD's adjusted gross margin of 32.9% was a 300 basis point year-over-year improvement. This progress is encouraging, especially considering a nearly 6% increase in generally lower-margin original equipment revenue. FCD also improved their adjusted gross margin to 30.6%, a sequential improvement of 140 basis points. For the first half of the year, FCD's gross margin was impacted by product mix. So we are pleased to see the quarter-over-quarter improvement. We believe FCD's margins will improve substantially in the second half of the year due to improved product mix and more effective demand planning at facilities. On a reported basis, second quarter consolidated gross margins increased by 170 basis points to 31.6%, despite net adjusted items within cost of sales increasing by $2.6 billion versus prior year. Second quarter SG&A increased $17 million year-over-year to $236 million. Despite this dollar increase, adjusted SG&A as a percent of sales was up modestly 20 basis points to 20.4% driven by solid top line growth during the quarter and our ongoing cost discipline actions. On a reported basis, second quarter SG&A increased by about $9 million, primarily due to a lower level of adjusted items. At 20.6% of sales, SG&A actually decreased by 70 points versus the comparable period. Our adjusted operating income in the quarter was $144 million, an increase of nearly $32 million year-over-year. Our robust adjusted operating margin of 12.5% was a 210 basis point expansion and delivered an exceptional incremental margin exceeding 41% year-over-year. As we indicated earlier in the year, we expect our 2024 performance to be a margin-first story, driven by improvements from our new operating model and discrete actions we're taking, combined with revenue leverage. We expect that as we continue to perform, we will be well positioned to achieve our 2027 adjusted operating margin target of 14% to 16%. By segment, FPD delivered a very strong adjusted operating margin of 16.9%, representing a 370 basis points and 200 basis points year-over-year and sequential improvement, respectively. FCD also increased its adjusted operating margin to 13.4%, which was up 230 basis points on a sequential basis. We also expect to see continued adjusted operating margin expansion in FCD during the second half of the year, primarily as a result of higher gross margins from operational efficiencies. On a reported basis, second quarter operating margins increased 160 basis points year-over-year to 10.5%, driven by our operating leverage and higher realized margins, despite the $7 million increase in adjusted items. Our second quarter adjusted and reported tax rates were approximately 21.3% and 23.8%, respectively. This quarter's reported tax rate was elevated considering the loss on sale of [NASS] and no associated tax benefit. We now expect the full year 2024 adjusted tax rate of around 21% higher than a year ago when we saw the release of discrete valuation allowances in certain jurisdictions. Turning now to cash flow. After six consecutive quarters of consistent cash generation from operations, the second quarter was an operating cash use of $13 million, driven by working capital requirements, primarily in accounts receivable and accrued liabilities. Our receivables increased as a result of the timing of this quarter's strong revenue performance, which was partially offset by an over $27 million sequential reduction in inventory, including net contract assets. Additionally, as expected and in line with previous practice, we paid our 2023 performance based incentive compensation this quarter impacting the accrued liabilities account. As a percent of sales, we saw our second quarter adjusted primary working capital become more efficient and decreased by 260 basis points year-over-year, as the 7% top line growth outpaced the 4% increase in our adjusted primary working capital accounts. On a sequential basis, this ratio increased a modest 90 basis points to 29.3%. For the remainder of the year, we expect our cash generation generated from operations to accelerate. As such, we anticipate our free cash flow generation to adjusted net income conversion rate of around 80% or more for the full year. Other uses of cash during the quarter included $71 million for dividends, capital expenditures and a term loan reduction and share repurchases. Through the first half of the year, we repurchased about 340,000 shares of our common stock for a little over $60 million in addition to returning $55 million in dividends to shareholders. As we execute our capital allocation commitments we announced last fall. As I referenced earlier, last week, we announced the acquisition of in-process LNG pump technology, which we believe will further accelerate our 3D strategy. This transaction exemplifies our capital allocation approach. Our inorganic pipeline is robust, and we remain interested in targets that will drive long-term returns and enhance our 3D strategy. We will remain disciplined with our capital allocation, and we believe our framework will guide us to direct our investment dollars to the highest return and long-term returns for our shareholders. In summary, while we are proud of the results we delivered this quarter and through the first half of the year, we continue to see opportunities to expand margins and earnings during the rest of the year. We also remain confident in our progress and ability to achieve our 2027 goals. Great. Thank you, Amy. I would now like to provide an update on our R&D activities across the LNG and hydrogen end markets that support our decarbonization growth strategy. In the third quarter of 2022, we acquired Chart Industries in-process hydrogen distribution pumping technology. We were able to commercialize the technology last year, and we are now receiving ongoing orders for the pumps. Our technology enables safe and reliable hydrogen fueling. In the second quarter, we booked $7.5 million related to the construction of 10 new fueling stations in the United States. We're excited about the opportunity to support the expansion of this green fuel source. Additionally, we believe the technology that we developed for hydrogen fueling can be used in other cryogenic gas applications. Last week, we announced the purchase of in-process R&D for submerged cryogenic pumps for liquid natural gas from a start-up company called NextGen Cryogenic Solutions. Flowserve has a significant presence in LNG across our pump, valve and mechanical seal portfolio, but we were missing the submerged cryogenic pump offering, which sits at the heart of the liquefaction and regasification processes. This acquisition from NextGen fills this gap with differentiated technology in a technically difficult space. We expect to fully commercialize our first variation of these pumps in the second half of the year, and we expect to generate bookings in 2025. We remain excited about the growth of LNG and we believe we will capture additional market share with a more comprehensive suite of pump products. In summary, we have made great progress to enhance our product portfolio through small technology acquisitions that built on our flow control competence and domain expertise. Diversification also remains an important part of the 3D strategy, and we continue to drive growth through enhanced focus, improved channel strategy and new product development. Our diversified bookings grew sequentially again in the second quarter, and we continue to apply our portfolio into end markets that present an above-average growth profile. During the quarter, we were awarded a contract from a major global chemical company to supply pumps and valves in the construction of a new commercial scale molecular recycling facility in Germany. This facility will convert over 50,000 tons of plastic waste annually into new polymers for use as feedstock into food safety, healthcare and other diverse industries. Lastly, on digitize, our ability to instrument our products with our Red Raven IoT offering positions Flowserve to provide true solutions for our customers through monitoring and predictive analytics, but also ensuring that we are in the best position possible to provide aftermarket services and solutions for these customers. In the second quarter, Red Raven helped one of our customers save millions of dollars by minimizing production downtime. Our predictive analytics notified our customer of an unstable operating condition in their process and advise them to promptly modify the dry vacuum system operating parameters. As a result, we were able to help our customers avoid significant unplanned downtime that would have cost an estimated $1 million per day in lost revenue. Examples like this increasingly demonstrate the value of our digital capabilities and the possibility of providing solutions to drive flow loop optimization. The Flowserve dry vacuum pump offering is now available and ready to be shipped Red Raven compatible. In conclusion, Flowserve is well positioned for another strong year of financial and operating performance, which supports our second increase to our full year 2024 adjusted EPS guidance. We are confident in the macro backdrop of our served industries as well as in our ability to capture both the run rate business and large project orders under our disciplined bidding approach. We are executing well, and we are excited by the opportunities ahead of us. We are confident in our ability to deliver at least 200 basis points of full year operating margin improvement in 2024 versus the prior year, primarily through our operational excellence efforts as well as the early benefits from our product excellence program. Lastly, we believe we are ahead on the journey to our long-term goals that we communicated at our September Analyst Day last year. Our near-term focus is to further build upon our operational momentum and continue to enhance our margins with operational and product excellence initiatives. We remain committed to our 3D strategy to deliver growth and catalyze on the macro drivers that exist today. We are pleased with our progress in the first half of the year, confident in our ability to build upon the success and are increasingly optimistic about our outlook. We remain committed to further capitalizing on the growth opportunities in the market today, and into the future that will deliver long-term value creation for our customers, our associates and our shareholders. Operator, this concludes our prepared remarks, and we would now like to open the call to questions. [Operator Instructions] And we'll go to Mike Halloran with Baird. Mike Halloran Let me just talk through the thought process in the second half of the year here and what it means for next year. So certainly understanding these comments that you've been talking about the last few quarters about how the seasonality is a little bit more level relative to history. Could you just give some more context there? And then more specifically, talk to some of the margin moves. It feels like there's some conservatism embedded in the margins in the back half, but I want to make sure I understand how the mix is moving around between aftermarket OE or any other variables that might hit that? Scott Rowe Sure. I'll let Amy start and then I'll probably add a few comments. Go ahead, Amy. Amy Schwetz Sure. I'll start with revenue. And I think as we've entered into 2024, we are coming off a year with really strong revenue growth. We knew that this was going to be a year about margin expansion rather than outsized revenue growth. And so you're seeing that play out in 2024. The first and second quarter up against easier comps, I would say, are supporting really nice revenue growth, and we'll see that moderate in the back half of the year. As we think about how this plays out into 2025. These large projects that we booked in Q2 are really going to be a 2025 revenue story versus a 2024. And so although we see those growth rates moderating, we think that we are building the type of backlog that positions us well going into 2025. And then I'll just comment overall that the internal messaging and push is really around leaning into growth in the second half of the year. So continuing to do what we've done, particularly around those higher-margin pieces of the business and you see that coming through in our aftermarket bookings in the second quarter at the level above $610 million. From a margin expansion perspective, we're really pleased with how we've moved through the second half of the -- or the first half of the year. And I'll comment specifically on FPD, which we really thought had an outstanding quarter from a margin expansion perspective. There was nothing special in there, Mike, but it was a well-executed quarter. So we saw mix shifting slightly favorably for us with the ability to drive aftermarket revenue slightly higher than we expected based on the strength of those bookings. And then our project revenue actually shifted a bit towards higher-margin projects that we see. So although I don't want to call that 16.9% operating margin as the new normal, I think you will definitely see Q1 margins as the low watermark. And so I would expect for the rest of the year that we'll deliver at sort of a 15.5% operating margins or better in the back half of the year, as we continue to really lean into operational excellence and growing the profitable pieces of that business within FPD. From an FCD perspective, we performed a little bit better than we thought we would in the second quarter of this year and that was driven in part by operational execution. It was driven in part by a slightly more favorable mix than we anticipated with more services and solutions revenue in the quarter than we'd expected when we began. That said, we still see room for further margin expansion in the back half of the year. That's driven partially by mix and more sort of automation and control valve type work, less project type work. But more importantly, by operational efficiencies we see coming through in the back half of the year. So bottom line margins this year are progressing nicely. The 12.5% that we saw this quarter was very strong, but we see the opportunity, as we've indicated to grow operating margins by 150 basis points or more in 2024. Scott Rowe And then maybe the only thing I'll add would be that we've worked really hard to minimize the variability between Q1 and Q4. The last two years, we've come out really strong in the first quarter of the year, including this year. And so that seasonality will still play out. The Q1 will be the lowest of the year for us. Q4 will still be the highest. But the variability between those quarters will be much smaller and we'll continue to work to close that gap. Mike Halloran So second question, Scott, you were talking about a more formal product line review launch, so a couple of questions related to that. One, was that embedded in the expectations you laid out at the Analyst Day? And two, maybe just a little bit more color, and I know you only launched on one, you're broadening it out. But a little more color on what you're seeing or early feedback of what the magnitude of the opportunity might look like and how that could be prioritize your time and capital internally? Scott Rowe Yes, absolutely. And so at the Analyst Day, we laid out kind of two big growth levers. One was operational excellence, where we committed 100 basis points to 200 basis points improvement and I'll just start there. That's gone incredibly well. We're seeing that in the results this year and we continue to see further upside to operational excellence. And then on the product excellence, we also committed to 100 basis points to 200 basis points of margin improvement. And within product excellence, we talked about two categories. One was product management and one was portfolio optimization. And so last year, at the beginning of the year, when we did our reorganization, we recommitted I will say, to really driving product excellence with a dedicated product management organization. And so that essentially unlock this capability to really review our product families and product portfolios in a much more robust fashion within each of the seven business units. And so the exercise that we kicked off at the beginning of this year in the first business unit is really on the product optimization. And so looking at the different product families within a business unit, understanding what we really like from a margin standpoint, a product SKU standpoint and a customer standpoint, and then taking decisive actions to either invest in products, move products out, raise prices and do all the things that we need to do to maximize the ability to generate value within those product families. And so the first business unit has been kind of in flight now for about four to five months. We've got clear visibility to the actions and margin improvement and what I'm really excited about is we believe we can move the margins up while continuing to drive focus on growth. And so we don't think we compromise growth with this program, but drive margins up substantially. And so we've got one business unit in flight. We'll launch the second business unit. We've already done all of the data analysis. We'll launch that next month in terms of starting to develop that action plan. And then we've got the third business unit going in flight by the end of the year. So in summary, we're excited about product excellence. We're still committed to 100 basis points and 200 basis points from the product excellence initiative. And I would say we haven't really seen the benefit of that year-to-date. And so that starts to show up at the end of this year but more predominantly into 2025. And then ultimately, that will continue into 2026 as well. [Operator Instructions] And we'll move next to Joe Giordano with TD Cowen. Joe Giordano Can you talk about like where the jumping off point from 4Q, right? So the margins of 4Q would be your best quarter. You talked about compressing this. So this -- how do you see that as like compared to it early and early thoughts on margin for '25? It's been a pretty big jump down each year. It's getting less, but like I just want to like bring this appropriately for people as we kind of set new expectations from here? Amy Schwetz Yes. So I think, Joe, as we look at finishing up 2024 and kind of moving into 2025, we're going to be focused on the things that we've been focused on the last two years. So really minimizing that differential between Q4 and Q1 and using that exit rate from an OI perspective to really drive performance in that coming year. That said, I don't think that we've fully solved the seasonality issue, particularly as a business that's looking to grow revenue. So I think that we'll continue to see 20 -- the first quarter of the year. We are lightest from both a revenue and an earnings perspective, as we move forward. But as we look at the phasing of some of these larger projects, we'll continue to focus on how do we manage that top line revenue in a way that really maximizes earnings, but also helps us on our working capital journey as well, which the more steady levels of revenue certainly helps with. Scott Rowe So I will just add, we're on this progression to the targets we laid out in -- for 2027 last year at the Analyst Day. And so everything we're doing is geared to driving towards the 14% to 16%. We made great progress this year. And so I'd say, while first quarter next year will come down slightly the full year, we should see another substantial step toward achieving these targets. Amy Schwetz Yes, absolutely. I think Scott's kind of laid out the road map in terms of how we see that with continued work on operational excellence, where we feel like we've done a lot of work and we're seeing it at the gross margin level, but with product excellence, really, really kicking in, in 2025 and providing us an opportunity to expand margins and get us even closer to our long-term target. Joe Giordano And then it was interesting to see like the targeted divestment there in the quarter. Are there more opportunities for stuff like that? Like how much of your portfolio do you feel like you've analyzed with that sort of lens at this point? Amy Schwetz We're going to continue to look through that. And some of the data analysis that Scott referenced is going to continue to help us do this. This was a relatively easy call for us to make. It allowed us to reduce our footprint, it was dilutive to earnings and it was something that once we found the right buyer it was easy for us to make that call. We're going to continue to look for those opportunities, although this was one that was probably a little bit easier than others might be as we continue to get better at both product management and portfolio optimization. [Operator Instructions] And we'll take our next question from Andy Kaplowitz with Citigroup. Andy Kaplowitz Scott, so you mentioned the bookings pipeline for Flowserve is up 8%, I think. So maybe you could elaborate on that pipeline. Do you still see other large projects out there in addition to what you booked last quarter? And then do you think book-to-bill can still average over 1 over the next few quarters or at least in the second half of this year? Scott Rowe Sure. Yes. In the prepared remarks, we did say the project funnel is up 8% year-over-year, giving us really good visibility to project work. And when we talk about the project funnel, it really is projects greater than kind of $5 million. And so we're talking about the larger type projects. Q2 obviously was really good. We had three very large projects in there. I don't see another incredibly large kind of near that $100 million mark in the near-term funnel. But we have a long list of opportunities, let's just call it, kind of $25 million to $50 plus million. And where we see those opportunities, we've got primarily Middle East. And so there's still a lot of activity in the Middle East, Saudi, UAE, Qatar. We've got some work that we've got visibility to in Oman, in Kuwait and so there's a substantial build out there of gas processing and then further downstream activities like refining and petrochemical. And so our outlook there is incredibly positive. On the power side, we saw our funnel up 22%. That's on the forward look one year out. And so a lot of that activity is around nuclear. And we've got very strong visibility to nuclear build-out in Europe and parts of North America as well. And so, we're pretty excited about the power outlook. And then on the energy transition funnel, it's up 40% year-over-year and kind of that new energy and energy transition for us is the fastest-growing end market. And while the projects aren't in the super large size of kind of greater than $50 million, we do see very robust project activity within energy transition funnel. And so the average size of that would be anywhere between $5 million and $20 million. So long story short, the funnel is up. We've got good visibility. We believe the full year book-to-bill is greater than 1, which implies kind of a second half of the year at over 1 as well. And I think that given the project outlook in some of the mega trends that we're following, we feel pretty good about certainly, our visibility through the end of the year but into 2025 and 2026 as well. Andy Kaplowitz And then can you talk about the return on investment that you expect from the new cryo pump acquisition that you made in LNG, at least versus that $0.05 that you're going to take that you talked about last week in the release, do you see sort of an immediate return in the form potentially more significant wins in LNG, either here in the second half of '24 or '25. How do you -- how should we think about the returns? Scott Rowe Yes. I'll talk about kind of our outlook there and then maybe Amy can talk about our returns profile against some of the other acquisitions and things that we look at from a capital allocation standpoint. But on the LNG side, we're very excited about LNG as kind of this transition fuel. It's not going away anytime soon. And with our pumps, valves and mechanical sealing offering, we get all -- we get a front row seat to all of the projects and the aftermarket activity. And when we looked at the portfolio of what we can provide within LNG, what we were missing was the submersible cryogenic pump, and it truly is the heart of the process for both the regasification side and the liquefaction side. So this is something that's been on the product development side for years at Flowserve. It's been something that we wanted to do. And what we found was kind of a creative path to acquire the in-process R&D or the license and technology of the cryogenic pump. And so we've got some further product development work to do through the end of the year. But we've got a clear path to doing those prototypes and the testing before end of the year and beginning to commercialize the product into next year. We think submersible cryogenic pumps is at least $250 million a year of kind of new equipment, but our pump can also be retrofitted into existing facilities. And so we're actually really excited about the opportunity to put our pump into existing applications that we were not -- we didn't participate in because we didn't have that product. And so this is something that we can easily see a $50 million a year of kind of revenue, maybe not next year, but certainly into 2026 and 2027 and we're excited about the growth of this product. Amy Schwetz And just from a return standpoint, we would look at this through the lens of likely would any sort of inorganic growth. So does it fit the strategy, which Scott's clearly outlined, is it accretive to margins? We believe it will be. And then are the long-term returns there. The one comment that I would make is something like this that we need to commercialize, we would actually expect slightly -- well, we would expect higher returns than we would on an existing business that may have less risk in terms of that commercialization period. So we're really excited about the potential returns that are out there. And in this instance, we are able to finish the acquisition of this in a way that actually sort of limits the risk going forward in terms of commercialization. So something we're very excited about. And then the last comment that I would make is what we've not included in the economics of a transaction like this is the ability for this product to help us lead pull-through of other Flowserve products into LNG facilities, which is an added benefit, we believe it may provide longer term. We'll go next to the line of Deane Dray with RBC Capital Markets. Deane Dray Scott, I'm always interested in hearing your take on the composition of the orders in the quarter. You highlighted the three large ones. But just looking deeper into that order book, what's your take in terms of the size and what that means? And then can you also give some color on the record aftermarket, is that the installed base coming through? Or are you doing something extra in terms of getting your access to those aftermarket orders? Scott Rowe Sure. I'll start with projects and then I'll talk about aftermarket and quite frankly, after a market was the highlight. So I'll spend a little more time on that. On the project side, we had three large orders, roughly $200 million across all three of those. They're in the Middle East, mostly around gas processing but also a chemical award. And again, we've got incredibly strong connections in the Middle East. We have a strong presence with the ability to make pumps, valves and seals in the Middle East, and then we've got an amazing team that's doing a good job with the end users there. We've got continued outlook and visibility to projects in the Middle East, and we're confident in our ability to continue to drive that business forward. When you get beyond those three awards, we did have a long list of project awards in kind of the $5 million to $15 million range. We had significant power bookings $70 million plus on the nuclear side. We had a lot of energy transition type work. And so a really nice balance across industries within the project bookings. But let me turn to aftermarket. We booked $614 million in the quarter. That's the highest level of aftermarket bookings we've ever had. It's the seventh consecutive quarter now over $550 million work. And I'd say there's two big drivers here. One, on the market side. Clearly, high utilizations across where our installed base is, so refining plants -- petrochemical plants, chemical facilities, power facilities, all running at reasonably high utilization levels, which is driving parts and service on our side. There's also some pent-up demand just -- I don't know if it's the COVID side, but just some deferred maintenance that's still coming through the system. And so that's helping us as well. But I'd say the second big driver for us was -- is really on the back of our new ore design last year, where we clearly segmented services and solutions in the pumps division and we segmented in a separate BU within our valve business. And so what we've seen by this enhanced focus is our ability to move up our capture rate on our installed base. And so through deliberate actions around quoting quicker, providing shorter lead times being more responsive in general, the mantra, quite frankly, is speed wins in our aftermarket business and so what we're seeing is our capture rates continue to move up within the aftermarket business. And so if we look forward, obviously, record bookings at $614 million in Q2. But we believe that we can continue to move this up. Our capture rates still have opportunity for improvement as we continue to drive speed in all aspects of the aftermarket business. We believe that we can continue to grow this side of the aftermarket side of our business. And so we're excited about what the teams have done. The new org design is, quite frankly, is unlocked some of this capability and provided more of a global perspective across both valves and pumps, and we believe we can continue to drive initiatives that lead to enhanced growth within the aftermarket business. Deane Dray That's exactly what I was looking for in terms of what was the drivers around the capture rate. And then second question, nuclear has come up a handful of times. You talked about opportunities and some activity in Europe and North America. Is there anything that you've seen so far related to power needs for data centers. That's -- we're hearing a lot more of that as an opportunity as Amazon making an investment in a nuclear plant. Anything on the small modular reactor side? And what are your opportunities? Scott Rowe Sure. I'll start power and general, I'll go to nuclear. I'll end with SMRs or small module reactors. So power outlook for us is we feel pretty good about what we're seeing there. I'm laughing because last year at our Analyst Day, we committed to -- was at 3.2%, Jay. We committed to 3.2% on the forward look. Clearly, we were understated there and missed some of the trends on the data center and AI. We'll put out some kind of new work on what we see that growth rate is. But power for us is a $400 plus million business a year. We're in pretty much all of the power applications, whether it's coal-fired power plants, whether it's natural gas, nuclear, everything else. So we have a massive installed base. And what we believe over the next couple of years is an inflection to increased power demand, both in the Americas and in Europe. Ultimately, we see that across other parts of the world. But after decades of power demand being relatively stable, we're now seeing, what I'll call, reasonably substantial growth and that growth is driven on the back of everything being electrified and this new kind of data center demand driven on the back of artificial intelligence. And so we feel that the outlook in power is substantial. We see existing power generation facilities, we see the utilization rates start to increase. We're seeing plans for expansions and capability or increases in generation within the U.S. And then we're also seeing substantial build-out across Europe and other parts of -- well, India and other parts of Asia Pacific as well. And so we're excited about what we can do in power. We've got a pretty good lineup of products across pumps, valves and seals that supports traditional power and nuclear. Then on the nuclear side, we believe that this is an area to provide incredibly clean and reliable and safe fuel regardless of any condition. What we're seeing is expansions in Europe, primarily on the back of EDF, the French nuclear authority that has the license for a lot of different nuclear applications in Europe, and they're moving into India as well. We've got strong relations with them on both our pumps and valve portfolio. And we're pretty excited about their plans as they go forward and pulling our product into their expansions. And then also in Europe and certainly in the Americas, what we're seeing is life extensions on existing nuclear assets. And so they're taking the existing life of that asset and adding a 20 or 30 year life extension to the nuclear facility and when they do that, it's a substantial aftermarket effort on our side to rerate pumps and valves and replace a lot of the existing equipment to make sure that our equipment is working for the full life of that extension that they've defined. And so overall, we see nuclear generation as something that will continue to grow. It doesn't happen fast, but we are now seeing substantial signs in our forward funnel of significant growth as we go forward. The power funnel overall is up 22% year-on-year. Our nuclear funnel is kind of right at that 20 plus percent a year. And so I think you can expect us to talk about nuclear for many quarters to come as we go forward. And then on the last question with small modular reactors. We are participating in several of the kind of the R&D or the technology development to support SMRs, but my view is that's still many years away until we get to a commercialized product and that becomes a meaningful part of our business. So what we're doing is we're working with a very select few players that we believe we're in an advantaged position with their technology. And our hopes are that by working with them, we'll get our pumps and valves spec into their process. But again, I'm not optimistic on the time line, that's probably still kind of 5 to 10 years out until it's commercialized. Amy Schwetz One comment I'll just add into that is that the hype is happening. So the first half of the year, we've seen a 20% increase in power bookings year-over-year. So this is not just a trend that we see playing out in the future, it really started in the first half of the year. I'm hopping on late from another call. So probably, if you touched on it, but I didn't hear anything about price. So I was wondering if you could maybe just give us some perspective on the pricing environment you're seeing. How much are you realizing to date? And in terms of the funnel, the order, the bookings, are you still kind of seeing some incremental value from kind of that value-added pricing or is that mostly normalized? Scott Rowe Sure. I'd say we're in a much better place than we've been in the last two years, and I'm happy that this hasn't been the first question out of the gate. But I'd say we're doing a much better job on pricing. Our cost inflation has moderated or subside in many parts of our business. We did announce the price increase at the beginning of the year, roughly kind of what I'll call more normal price increase in that 4% to 5% and we believe that we're doing a much better job kind of realizing that price increase, making sure that it sticks and making sure that we're on the positive side of the price/cost curve. And so that would be for our general business. The mechanical seals are kind of run rate valve business and then the more industrial-type pumps. And then on project pricing, we've talked last quarter and even the quarter before about our selective bidding and making sure that we get the margins that we deserve for large complex projects. And what I would say is that our team has done a really, really good job working through a very complicated landscape with EPC and end users, but we're really making sure that we can deliver the price and the margins that we think are acceptable for some of the risks that we take on in the larger projects. And I'd say the overall project pricing environment has gotten better. It's still not perfect, but it's allowing us to continue to walk up our project pricing. And so overall pricing environment has improved substantially from a year ago. We continue to see this as constructive as we move into the back half of the year and into 2025. And then I'd just say as part of the product excellence initiative, pricing is a big component there. And I think what you'll see over the next year or so is that we get a lot more disciplined on pricing. We'll be more specific in product families and customers on pricing and so just a more mature approach to pricing as we kind of roll out the product excellence initiative. Damian Karas And then you called out the 3D bookings growth above 25%. So I'm kind of curious on the 3D. Maybe you could just give us an update on Red Raven, how the adoption is tracking? Any updated views on what you think is possible there? Scott Rowe Sure. Yes. We continue to make really solid progress here. I do wish it was faster. We're up to kind of 2,250 assets that we've now instrumented. What I would say on a very positive note is the system is working incredibly well. The customer feedback is really high. And what we're finding is when we do instrument pumps or valves within a customer facility, we typically get repeat orders or asking to kind of add more assets to our monitoring program and our prediction. And then the other thing I'd say is the algorithms that we developed, it's been almost kind of five years now. They continue to get better with all of the data that we're collecting and what we're finding is that the system is doing a really good job on predictive analytics and allowing our customers to avoid unplanned downtime. So in my prepared remarks, we talked about this happening with a dry vacuum product, where we saved the customer $1 million a day of potential lost revenue because we're able to alert them to a process condition that they weren't aware of through their traditional DCS system. And so I'm still very excited about this. I do think if we fast forward 10 to 20 years, I think most, if not all, full control will be instrumented. So I feel like we're doing the right things. I also feel like we're at an inflection point in terms of Red Raven adoption. We've got some great case studies now, and I think we'll see this growth rate pick up even more than what it is. And then finally, I'll just say we believe that the digital side, the ability to instrument our equipment, the ability to understand kind of flow conditions and provide these predictive analytics truly allows us to be a much better solutions provider when it comes to full control. And so when we add this system to a facility, we become very close with the operating team, and it allows us to pull through parts and incremental services. And so we're already seeing a tremendous benefit on our aftermarket when we do have Red Raven installed at sites. And so we're going to keep focusing on this. I expect the inflection rate to come up, and I do expect us to talk more and more about our ability to generate solutions within a full-loop environment. We'll go next to the line of Nathan Jones with Stifel. Nathan Jones I wanted to go back to gross margins. I guess the first question here is, if I look back at 2019, you had gross margins heading in the right direction at that point. And then obviously, COVID derailed everything. And we saw compression from there. In '23-'24, you're back to a point where revenue is higher than it was in 2019, but gross margins are still 100 basis points or so lower. Can you talk about what the difference is in the business today versus five years ago that still has gross margins slightly below where they were in 2019 on higher revenue? Amy Schwetz So I'll start with -- I mean, we think that we can get back there, Nathan. And so I appreciate the question in terms of how we're thinking through the operating margin expansion that we've got embedded in our long-term targets. So we've talked this year about expanding gross margins 150 basis points or I'm sorry, expanding operating margins by more than 150 basis points. As you can see in Q2, the majority of that is coming from gross margin expansion. And so we believe that the levers that we've outlined in terms of operational excellence, which is already showing dividends and product excellence can work to further expand those margins and get us back to those 2019 levels or, frankly, higher than that as we move forward. The one thing that I would point out with respect to 2019 is operating margins in 2019 were 11.3% versus the 12.5% that we saw in the second quarter of this year. So I believe we'll end 2024 at an operating margin higher than what we saw in 2019, which frankly puts us on solid footing to continue to deliver value to our shareholders both via gross margin expansion and cost control within other cost categories to make the company stronger than what we've seen in those previous years. Nathan Jones I guess the follow-up then is going to be gross margin. Just specifically on FCD, because if you look back historically, that's where gross margins have typically been higher. FPD is actually kind of back to where it has been historically on gross margins, but FCD is the one lagging. So can you maybe talk about if there's something structural that's changed in the business? You used to be able to kind of get towards mid-30s gross margins for FCD. And if there's nothing that structurally changed, what's the path to getting that business back to mid-30s gross margin? Amy Schwetz Yes. So I would say our long-term targets for FCD from an operating margin perspective, we're a little bit lighter than where we've seen that historically. And that is due to a mix shift in that business, both in industry, but in the balance that we're providing. So more of a focus on really the isolation valve piece of the business, and we want to continue to grow our ACV, our automation business, but isolation balance have been growing a little bit faster. So that mix has been impacting us. And I'll just comment as we talk about power generation, that is isolation valves that are driving some of that growth that we see over time. That said, we see a tremendous opportunity for growth in the valve business moving forward. And frankly, FPD, we're not stopping on margin expansion, but we're at our long-term targets in the second quarter in terms of operating margins. So what do we need to do with FPD. The start is in the second half of the year, the operational excellence and execution will get better. We'll see that kick in, in a bigger way than what we've seen in the first half of the year. And as Scott pointed out, product excellence is really going to be a 2025 story, but that journey starts this next quarter for our valves business. So we're confident that those margins will be expanding not just in the back half of the year, but as we move into 2025. This is Eric Look on for Brett Linzey. Focusing on Asia-Pacific, it's nice to see a tick up 5%, improving from last quarter's 1% growth. How should we think about China's contribution to the region in terms of sales and bookings and maybe some color on Asia-Pacific outside of China as well? Scott Rowe Sure. Within China, we've got two large facilities that essentially do China for China, both on the pump side and the FCD side. And so we feel like we're reasonably well positioned there. I would say, at this point, we're not investing in China, but those teams are clearly geared towards winning projects within China and then I'd say probably more importantly, capturing the aftermarket within our installed base. And so, I'd say that's kind of the focus area for China at this point. And then broader Asia-Pacific, when we look at that year-over-year, we look at it even compared to years ago. That business is slightly down. I'd say it's the investment across Asia-Pacific is a little lower than what we would expect. But I do still -- I believe that there is optimism in terms of projects and run rate increases, as we kind of move forward into 2025 and 2026. And so well represented in Greater Asia-Pacific. We've got teams in most countries. And I think we've got an amazing installed base. And so the aftermarket business continues to perform reasonably well, but we haven't seen the project business like we expect. And so again, I think on the forward look, I think it comes up from here. But the China growth and commitment is not where we're going to put our focus and efforts in the foreseeable future. We'll take our final question today from Joe Ritchie with Goldman Sachs. Joe Ritchie So Scott, your comments on the aftermarket business for like super positive. And I'm kind of trying to think through this beyond 2024. And so is it right to consider $600 million is kind of like the new quarterly run rate, and that's something that we should basically capitalized into next year? Or just any thoughts around the sustainability of the current orders and how that translates into revenue going forward? Scott Rowe Sure. Like I said, we haven't seen anything crazy here or one-off or anything that's like juicing the bookings in the second quarter. And what we've seen, if you kind of projected this out over the last 18 months quarter-over-quarter, what we've seen is just nice, steady progression here. And again, I think there's a market element to this with higher utilization rates, a little bit of pent-up demand but not a ton. We did have spring turnarounds. And so there was an uplift in the second quarter around that. But I'd say overall, the market activity should continue as we look into the forward quarters here. And then secondly and probably the biggest driver is the new organization design creating enhanced focus on both pumps and our valve business to really make sure that we're winning our entitlement here. And so we have a massive installed base of pumps and valves around the world. We do track our capture rate, our ability to get the aftermarket on that installed base and I'd just say there's lots of room for improvement on moving this capture rate up. And with all of the initiatives around being more responsive, quoting quickly, shorter lead times, what we're seeing is those capture rates move up. And so, I think this is sustainable. We may tick down a little bit maybe in the third quarter or something as we look forward. But I'd say that overall trend in growth rates should continue at a nice steady progressive rate as we go forward. Joe Ritchie And then my one follow-up for Amy. Just on free cash flow for the quarter was a tad bit lighter, but I know that there's sometimes timing issues. It seems like receivables uptick this quarter. So is it right to just kind of think about that as a timing issue? And then what are just your expectations for free cash flow for the year? Amy Schwetz Yes, absolutely. So we knew that Q2 was going to be a challenge from a free cash flow perspective. The accounts receivable build we saw was not as a result of any collection issues but more timing related in terms of when those products went out the door when we hit milestones on percentage of completion projects. So we think we're set up for a really strong second half from a cash flow generation standpoint. And in fact, really picked up our guidance a little bit on our first half results. So we were previously anticipating kind of 70% to 80% free cash flow conversion in the year. And we're now thinking more of some level of 80% or better for the full year. So it points to a really strong cash flow generation in the second half of the year as we collect on the strong revenue conversion that we've had in the first half of the year and expect in the second half and importantly, continue to make progress with respect to inventory management. So we're excited about where we're going, both with primary working capital management and free cash flow generation more broadly. This concludes today's conference. We thank you for your participation. You may disconnect your lines at this time.

Fiverr International Ltd. (FVRR) Q2 2024 Earnings Call Transcript

Jinjin Qian - Executive Vice President, Strategic Finance Micha Kaufman - Co-Founder, Chief Executive Officer and Director Ofer Katz - President and Chief Financial Officer Good morning and thank you for standing by. Welcome to the Fiverr Second Quarter 2024 Earnings Conference Call. At this time, all participants are in listen-only mode. After the speaker's presentation, there will be the question and answer session. [Operator Instructions] Please be advised that today's conference has been recorded. I would now like to hand the conference over to our first speaker today, Jinjin Qian. Please go ahead. Jinjin Qian Thank you, operator, and good morning, everyone. Thank you for joining us on Fiverr's earnings conference call for the second quarter that ended June 30, 2024. Joining me on the call today are Micha Kaufman, Founder and CEO, and Ofer Katz, President and CFO. Before we start, I'd like to remind you that during this call we may make forward-looking statements and that these statements are based on our current expectations and assumptions as of today, and Fiverr assumes no obligation to update or revise them. A discussion of some of the important risk factors that could cause actual results to differ materially from any forward-looking statements can be found under the Risk Factors section in Fiverr's most recent Form 20-F, and other filings with the SEC. During this call, we'll be referring to some key performance metrics and non-GAAP financial measures, including adjusted EBITDA, adjusted EBITDA margin, and free cash flow. Further explanation and a reconciliation of each of the non-GAAP financial measures to the most directly comparable GAAP measure is provided in earnings release we issued today and our shareholder letter, each of which is available on our website at investors.fiverr.com. Thank you, Jinjin. Good morning, everyone, and thank you for joining us. Our Q2 results demonstrate continued strong execution and the resilience of our business. Both revenue and adjusted EBITDA came in above the midpoint of our guidance as we continue to expand customer wallet share and improve monetization. We are committed to driving profitable growth and delivering shareholder value in a fluid environment. I'm pleased to report that we have completed the $100 million buyback program announced in April. We remain highly confident about the long-term opportunity of our business and believe our strong cash flow and strong balance sheets allow us to invest in our business while returning capital to our shareholders. I'm very excited to be here today. It has been an incredibly busy and fulfilling few months at Fiverr, culminating in the announcement of our summer product release last week. I want to thank our entire team for their hard work. The level of energy and dedication, especially in the last few weeks, reminded me of Fiverr's early days when we were just a small startup. Fittingly, we are starting up a number of new ventures as we look to take our business to the next level. First is the expansion of Fiverr to enable freelancer hiring capabilities. With the introduction of a professions-based catalog and the ability to initiate time-based transactions and contracts, we are enabling businesses to hire long-term freelancers who act as part of a team with ongoing tasks and goals. This is not an area we competed in historically, but as we increasingly go upmarket and lean into complex service categories, it becomes essential to round up our offerings. We believe it will significantly expand our direct addressable market, allowing us to open up top-of-funnel, specifically for traffic with long-term hiring intentions. It will also allow us to capture more of our customers' overall freelance hiring budget. The expansion of Fiverr to a multi-solution platform that enables long-term hiring is also an important message to our community. In an environment where AI seems to have the potential to upend many professions, the line between human services and AI-generated services is blurring. The professions-based catalog puts talent at the center of the marketplace experience. To our buyer community, it underscores our value proposition in connecting them with the best human talent around the world for authentic, creative work. To our talent community, the mission of Fiverr since Day One has always been to bring them opportunities and empower their success, and that commitment has not changed in the face of AI. It is our passion and responsibility to help talent navigate the changing landscape, discover their skills, and translate them into a career. Earlier this month, we unveiled our first-ever Breakthrough Achievement recognition to celebrate freelancers who have achieved significant earning milestones on Fiverr. It is extremely rewarding and inspiring to see people making $1 million or even $5 million through our platform by just doing what they love. Whether you are a musician or scriptwriter or Shopify expert, and no matter where you come from, it is all possible on Fiverr. The second theme of our Summer Product Release is deepening the integration of Neo, Fiverr's AI tool, throughout the marketplace experience. As GenAI applications quickly shift consumers' Internet behavior and expectations, we want to stay ahead of the curve to build a more personable experience on Fiverr. At the same time, tests and data in the past six months have shown that not everyone prefers an outright chatbot experience when it comes to shopping. So our strategy for Neo is to incorporate it as an assistant throughout the funnel to help customers when friction arises. For search, Neo provides the guidance you need to navigate Fiverr's massive catalog of services and talent, and it is trained to understand customers' past transactions and preferences to provide the most relevant recommendations. When it comes to project briefing, having Neo is like having a strategist by your side. It transforms customers' ideas into a structured brief document that not only looks good, but also delivers better business results. Neo can also help customers write more detailed reviews faster by generating content based on transactions and providing language assistance. We are in the early innings of unleashing the full potential of AI in our marketplace, and we believe it'll be a multi-year tailwind for us to drive product innovation and growth. Lastly, I want to say a few words on the acquisition of AutoDS. For us, the deal is strategic for a number of reasons. Fiverr was founded on the belief that everyone should have the opportunity to find financial independence. The creator economy is the epitome of this community. And competitively, we have a strong foothold in this segment. We are passionate about continuing to support and empower this community. Like the Fiverr Millionaires that I mentioned earlier, there is something emotionally gratifying in witnessing and contributing to their amazing stories. Secondly, while dropshipping is not exactly a new business, with the rise of fast-fashion e-commerce sites like Temu and Shein, and the continued strength of social media, we are seeing dropshipping-related categories experiencing tremendous growth on Fiverr. That includes Shopify development, e-commerce management, video ads, and UGC video, to name a few. We believe the deal can create many synergetic opportunities for us to lean into growth. Lastly, and in alignment with our expansion to a platform play, we are taking the opportunity to fold in a new subscription-based revenue stream with strong synergy and growth potential. This will add to our value-added product portfolio, which includes Promoted Gigs and Seller Plus, and further strengthen our business's overall financial profile. To wrap up, we are expanding our business from a simple marketplace to a complete freelance talent platform for businesses of all sizes. We are also diversifying our business model to capture customers' freelance spending and provide them with multiple value-added products and software solutions. We continue to operate at the highest level of discipline to drive consistent margin expansion and free cash flow generation. We are committed to profitable growth, robust free cash flow, and a disciplined capital allocation strategy that aims to deliver long-term shareholder value. With that, I'll turn the call over to Ofer, who will share some financial highlights. We delivered another strong quarter of results. Revenue for Q2 was $94.7 million, up 6% year-over-year, above the midpoint of our guidance. Adjusted EBITDA was $17.8 million, near the top end of our guidance and representing an Adjusted EBITDA margin of 18.9%. Importantly, Adjusted EBITDA margin increased by 180 bps year-over-year, which underscores our commitment to driving steady, measurable operating leverage. We remain confident in our ability to achieve a 25% long-term adjusted EBITDA margin in the next three years. We also continued to generate impressive cash flow. Operating cash flow was $21 million, up 11.9% year-over-year. Free cash flow was $20.7 million, representing a 12.5% year-over-year increase and an free cash flow margin of 21.8%. This results in a strong balance sheet which we intend to use to increase shareholders value through a prudent capital allocation strategy. As Micha mentioned, we have completed the $100 million share buyback which was authorized in April, and we are committed to optimizing our capital allocation strategy to deliver shareholder value. Over the next three years, we expect to continue growing free cash flow generation with a CAGR in the mid-teens. There are multiple ways we can get there. But as I often say, we always model based on what we know. Based on our line of sight today, we expect to achieve this through steady revenue growth, continued margin expansion, strong free cash flow generation, accompanied by active share count management. Unpacking our Q2 results, we continue to see our strategy of going upmarket work really well, with spend per buyer showing a robust growth of 10% year-over-year. We also see AI continuing to have a net positive impact on our business. It is important to note that we are starting to see stabilizing and improving trends in simple services. As we mentioned in prior quarters, we believe the low-end transactions within the simple service categories were getting impacted the most. As the mix shift within those categories improves towards the higher end, we believe the overall durability of those categories shall improve over time as well. There are also certain metrics in Q2 that didn't perform as strongly as we had anticipated. Active buyers were 3.9 million, down 8% year-over-year, and overall GMV decelerated in Q2. Both were impacted by a slowdown in traffic started in June as the strength we saw in the earlier part of the year proved to be more of a pull-forward rather than a sustainable turn of trends. These trends serve as a reminder for us that we are still in the middle of a macrocycle, where higher inflation and interest rates impact the immediate cash flow of small businesses, erode their confidence in spending, as they try to preserve more cash and delay large projects for potentially rainy days ahead. As we enter into the second half of this year, we are expanding our product portfolio both organically and inorganically to create additional growth catalysts, as Micha covered extensively in his remarks. Our seller monetization programs such as Promoted Gigs and Seller Plus continued to show strong growth momentum and the addition of AutoDS will further strengthen our overall take rate. We believe these efforts will keep us on track to deliver the targets we set at the beginning of the year. For the full year 2024, we are raising the bottom end of our guidance and now expect revenue to be in the range of $383 million to $387 million, representing year-over-year growth of 6% to 7%. We are seeing the volatility in June continue into July, and we anticipate Q3 revenue growth to be relatively muted. We expect Q4 revenue growth to improve as the continued product development and the addition of AutoDS create additional growth catalysts. In terms of underlying drivers, we now expect active buyers to decline slightly more than we previously anticipated, and spend per buyer to continue growing at a robust pace. We now expect the take rate to increase by approximately 250 basis points as we continue to expand our value-added product portfolio. For adjusted EBITDA, we expect full year 2024 to be in the range of $69 million to $73 million, representing an adjusted EBITDA margin of 18.4% at the midpoint. We are confident that we can continue making steady and consistent progress on our adjusted EBITDA margin to reach 25% by the end of 2027. With that, we'll now turn the call over to the operator for questions. Thank you. [Operator Instructions] And now we're going to take the first question and it comes from a line of Ron Josey from Citi. Your line is open, please ask your question. Ronald Josey All right. Thanks for taking the question guys. So I want to ask about the product and then maybe a little bit more about just broader visibility. So on the product, look, I think it's really fascinating the expansion to a broader marketplace with the hiring platform. And so, specifically, Micha, I wanted to hear a little bit more about the benefits of Neo as it relates to conversion rates? And then insights on overall launch plans to have it fully integrated in it. And as we also think about the product, I'd love to hear more from a professional-based catalog, just how you see demand and supply evolving on the marketplace over time as you bring everything together and become more of that hiring and marketplace platform. And then just a little more details on the macrovolatility, the pull forward early in the year and then June, July comments. Was this just a change that happened in June, July and as interest rates maybe come down? Any insights on maybe when we might see some stability here? Thank you. Micha Kaufman Good morning, Ron. Thanks for the questions. I'll try to take them by order. So the first one was, I think, about the product release and specifically about Neo. So essentially, I think as I've said in my opening comments, the possibility of actually using AI to make our product better, it's pretty much endless. And we're in the very early stages of doing that. And the experimentation that we've done with Neo as a personal assistant within the Inbox, which was the first version of doing it, taught us a lot about how our customers were actually using it and how it improved the conversion in briefing. Now it allows buyers to complete, and it leads to higher conversion as a result. And so, the idea here is that we're graduating Neo to get out of the Inbox and essentially being integrated in all of our experience. Right now, it's being rolled out gradually because we want to test its accuracy and performance. But essentially, you can find it as a personal assistant throughout the experience. So it allows customers to search better, to be more accurate about their needs, and as a result, get much higher quality match. But it also has awareness about where it exists. So if you're looking at a specific page, you can ask it questions about that page. So it helps people make decisions and get to what they're looking for better. The same goes with the integration in briefing. If customers have a brief pre-made, then they can just upload it. And we help make that brief even better. But if they don't, then the technology that is behind Neo actually helps them write a better, more accurate brief. And again, as a result of that, gets matched with a much more specific cohort of potential talent that can do the job. So essentially, it's a big part of our summer release. We're very happy on how it's progressing. As a new technology, as we scale it up, it takes a little bit of time. We're in the process of gradually opening this up for more customers. Second question was about the profession-based catalog. So essentially, one of the things that happens in this idea of graduating for a market base to a platform is -- historically Fiverr was just a market base for predefined services. But those services are being offered by professionals and we've noticed that a lot of our customers, when they search for something, they do not necessarily search for a specific service, but they do search for a specific talent. And as a result of that, we created a new catalog that is very much focused on talent, skills, professions, rather than specific services. And again, it allows customers to be more naturally matched with our talent. If you connect this with new contracting forms, like the possibility of paying based on hourly rates, then that completes or upgrades, enhances the platform and the possibilities of customers to actually engage with talent. I think your last question was about what we're seeing with macro. I think as Ofer mentioned, we've seen some volatility during June. First, macro environment continues to be challenging in terms of SMB and the sentiment of hiring. And I think that there's a few stats that are worth calling out here. So we have the small business index that continues to linger at the lowest levels in a decade. You have the job opening that are down 7% year-over-year and in the tech sector, specifically they're down 17% year-over-year and you have professional staffing that is tracked through staffing hours that is also down 7% year-over-year, which is slightly worse than it was a year ago. So, all in all, when you think about the hiring space, the hiring space is not seeing its brightest moment right now. In addition to that, what we've seen during June was some slow -- slowness in top-of-funnel traffic for us across the platform. So, I think that from a matrix perspective, it's more visible in terms of impact on active buyers and less on spent per buyer. And spent per buyer has been growing pretty aggressively, double digits. And the efforts that we're doing in going up markets continues to pay off. And from a category perspective, we're seeing some more volatility among larger projects, which is something new. And I think that this tells more than anything else that what we're seeing is something that we can't call a steady trend. Right now the market is a little bit volatile. Some of it is seasonality, some of it is AI in some categories, some of it is just macro. But in reality we see among larger projects we've seen some more volatility. At the same time we're seeing some more stability on simple projects, which is slightly different than what we've seen in the first few months. So we're just calling out those facts. It's hard to call them a trend at this point. Thank you. Now we're going to take our next question. And the question comes from the line of Bernie McTernan from Needham & Company. Your line is open. Please ask your question. Bernie McTernan Great. Thanks for taking the questions. Maybe just to start, I'd love to dive into AutoDS a little bit more and just learn maybe what capabilities that the acquisitions bring that you didn't have before or for its customers and probably most importantly how it's supposed to impact the financials in the second half of the year. And then, I think based on the commentary of the take rate being up 250 basis points this year, it implies GMV down year-over-year in the second half of the year. So just wanted to make sure I was triangulating that right. And then, I know it's early, but how to think about if we should be expecting, in your view, re-acceleration in 2025 or not, or just given the comments of the 2027 targets involving strong revenue growth, just maybe the puts and takes in getting there in terms of your thoughts, in terms of the ability to continue to expand the take rate, how M&A could play in that, but also importantly GMV growth? Micha Kaufman Good morning, Bernie. Thanks for the questions. So AutoDS, essentially I think as we said in the opening comment, dropshipping is a category that has been on Fiverr for many, many years. And we've been witnessing a lot of growth in this category. I've been saying in previous quarters that Fiverr has identified a number of faster growing categories in which we intend to double down. And in some cases, it's doubled down organically. And in some cases, there's an opportunity for inorganic growth as well. So we had a very sizable community of people that are either dropshipping or offer services related to dropshippers. And what we're doing with the addition of AutoDS is expanding this space also into the software solution. So that allows us to really double down and accelerate. AutoDS is practically in the software space related to dropshipping, is the number one player in the world. It's a fast growing company, we love the team, it's extremely synergic with our business for a number of reasons. It allows us to double down on dropshipping, e-commerce, social media, user-generated content, and video categories, which is, as I've said, some of the fastest growing categories on Fiverr. It's a community that we know very well and feel very strongly about. And I think competitively, it allows us to extend our offering and grow this further and also add to the value chain by providing more products for them. It's a community that is in many ways rooted in Fiverr's origin. And we're very passionate to empower them. We talked about this idea of the Fiverr Millionaire Award. And this connects really to self-made people, people that have built their businesses and are able to grow it. And lastly, I think it creates a diversified revenue stream, adding its subscription base, which is another step towards making our business, not just the market base, but also a platform that provides freelancers with software solution on top of access to opportunities. Ofer Katz I think the second part of the question is relates to take rate and impact on financials. I will start by saying that we are happy and proud to end Q2 above consensus, both for revenue and EBITDA. And with the confidence to reiterate the guidance for the year, both on revenue with a slight increase in the bottom range, reiterating the EBITDA. And I think this takes into consideration the fact, and Micha referred to the -- what Micha said earlier about June and July weakness results in weak joining of new buyer, of active buyer, compensated both by spend per buyer, growing on double digits and take rate extension. And I think that looking at a spend per buyer, our spend per buyer has a robust growth because we're investing in going up market for some time. It's the maturity of investment with the add-on of the summary list. Hourly rate features that we didn't have before, loyalty program. Those types of features allow us to double down on the community with a bigger wallet and increase the engagement relationship experience to a new level. And the second part that's compensated from the active buyer is the take rate. And take rate has expanded over the last few years with new features that we have added alongside the marketplace. And I'm going all the way back with the Promoted Gigs and then Seller Plus, and I think the AutoDS falls into the same bucket, allowing our community to further utilize our offering to make money. And by having said that, we anticipate that the integration of the community will take some time and then the benefit of the AutoDS will fall into the take rate with much of the opportunity ahead of us. You asked about 2025 and 2027. I think that we put some timeline to the 25% EBITDA in 2027. This is based on the assumption that we continue to grow and continue to improve EBITDA. I think that's what we've been doing ever since. There is no step function or hockey stick. It's just about continuing to do what we're doing and make sure that the fundamentals continue to work. Thank you. Now we're going to take our next question. And the question comes from the line of Jason Helfstein from Oppenheimer & Co. Your line is open. Please ask your question. Unidentified Analyst Hi, this is [Steve Rolman] (ph) on for Jason. So just one question on the consolidated take rate. So where do you see the ceiling on take rate over time kind of long term as you kind of look towards that 2027 target or the 2027 targets you put out today. Thanks. Micha Kaufman Hey Jason. So the question -- So essentially the -- if you think about the two parts of take rate, there's the transactional portion of it, and then there's the added value services and products that we offer to our community. The transactional portion of it hasn't really changed. And the growth that we're seeing is coming from the value-added product. So we haven't cut this. For as long as we can continue generating products that our community loves using and thinks that they're worth spending, we'll continue doing that. And we have quite a few in the pipeline. And therefore, we haven't cut it. And the transactional portion has pretty much remained the same. So that's how we're thinking about this. Thank you. Now we're going to take our next question. And the next question comes from the line of Doug Anmuth from JPMorgan. Your line is open. Please ask your question. Douglas Anmuth Great. Thanks so much for taking the questions. I just wanted to talk more about the Summer Product Release first, the hiring of long-term freelancers. Micha, maybe you can just talk about what you've seen here in terms of demand from buyers just as you built this product and kind of the drivers behind it. And then how we should think about monetization, is it still project-based or is there a different revenue structure there? And then Ofer, just on the full year outlook, maybe you can just talk a little bit more about what drives the confidence in the 4Q revenue acceleration. Thanks. Micha Kaufman Good morning, Doug. Thanks for the question. So, the Summer Product Release, as we go up markets and as we become more for our customers, they can envision doing more with us. In some cases, when you think about the predefined catalog of services, in some cases, it's very hard for customers to define their need in the format of a well-defined service with a beginning and an end. In some cases, when they need to hire talent, all they know is that they need a highly qualified graphic designer for three months because they have a variety of projects. Some of them, they're not even aware of what their specifics are, but they know that they have a lot of pressure right now and they need talent for the next couple of months. When that is the case, the best way of doing that is not necessarily going through the gig or services catalog, but rather to find the right talent and engage in an ongoing arrangement, which is why we created this mechanism. Now, it's not competing with the services because when you know exactly what you need and that is well-defined and it has a beginning and an end, it's very easy for our community. They're very accustomed to providing the transparency and clarity of having a predefined scope of work where you know how long does it take and exactly how much it's going to cost. But these are the more variable tasks, the more variable ongoing projects. And so, both the community from the supply side and the demand side have been asking for this. And we're happy to get to the maturity of extending our marketplace into this platform idea that really allows multiple ways of engaging with talent and multiple ways of contracting and paying to talent. So we just launched it. The community is highly, highly excited about this. Obviously, we're seeing a lot of transactions coming into the system already. But since it's been about a week, there's no numbers that we can talk about at this point. Ofer Katz The second part, Doug, of the question was about the confidence in Q4 revenue. I think the confidence is based on what we are seeing, products that we have released and numbers of potential spend per buyer growth and active buyer. I think that the current guidance implies more muted growth for GMV this year. And from a product standpoint, we haven't taken into account any impact from product release. We do think that professional catalog and time-based contracts open up a whole new world with super funnel traffic. Historically we haven't compete in this area at all, so there's definitely a potential to drive additional GMV uplift in the second half. So all in all, when we build a model based on what we see, we think that the add-on of the AutoDS later this year to our audience will have a positive impact on top of everything that we are doing internally. And the sum all is a nice exit rate for this year. Thank you. Now we're going to take our next question. And it comes from the line of Andrew Boone from JMP Security. So your line is open, please ask your question. Andrew Boone Good morning, Thanks so much for taking my questions. Micha, you've been fairly clear that AI has been a net positive, but can you talk about what you're seeing on the simple tasks and whether there's a path to underlying stabilization for those categories? And then secondly, as you transition from a marketplace into more of a platform with software solutions, how should we expect that to manifest going forward? It sounds like AutoDS is going to be operating independently. How do you think about the synergies and then how do you build out more software solutions and what's the obvious adjacencies that you're seeing there? Thanks so much. Micha Kaufman Good morning, Andrew. Thanks for the question. So starting with AI. So essentially AI continues to be net positive for us. We're seeing -- stabilizing and improving trends on simple services. We mentioned in the past that AI is impacting low ticket size jobs mostly. So we continue to see improving trends on simple overall mix of projects. So the overall mix of projects shifts towards higher end skills. Now, several quarters in, we are actually seeing that in our -- or this in our data. So for example, writing and translation as a vertical, is the vertical with the biggest exposure to AI impact. In Q2, we're actually seeing traffic in that vertical improved 10 percentage points in terms of year-over-year growth rate compared to Q1. And on complex services they're still growing much faster than simple and neutral categories, but the growth rate has moderated recently due to the volatility that we've been speaking about in June and July. That said, with us now opening professions catalog and hourly contracts, this will open up new funnels and create growth opportunities, especially for complex services categories. And remember that we have over 700 categories. So our exposure to specific categories is relatively low, and seasonal trends in categories spend are a regular thing in our line of business. When we think about the overall mix complex is in the mid-30s of GMV and simple is about 20%. I would be careful about calling anything we've spoke about on June and in July a trend. Because it's very hard to see stable things. Things seem to change over the year, and as I've said, there's many reasons why that is, and I would wait before we can actually call it a trend. The second question was a transition to platform. Okay, so essentially, when you think about the progression, the way we have developed over the past couple of years. We started from being a gig market base where there's very well-defined services with timing and price associated with them and people can just come in and order. Over the years, we've been offering a long list of or a multi-solution, building a multi-solution platform where our customers can actually engage in a multitude of ways with the talent on the platform depending on their needs. And what we're trying to do is, we're trying to fit the solution with the right need. So what we've been doing with Fiverr Pro and Fiverr Enterprise, what we've been doing with project management, success management, the addition of agencies into the platform, Fiverr Pro, now the profession, and the hourly based contracts. All of that completes a platform with multi-solutions for our customers' needs. On top of that, we have software solutions for specific needs that could be either our sellers or our buyers depending on the solution and AutoDS is a part of this. So as I was saying in the beginning, dropshipping is a very lively, well-growing category for us. By adding not just the community of AutoDS, but their software solution, because this is what they are, they're a platform that solves all the needs of dropshippers, we're able to enjoy those synergies, offering software to our dropshippers and our freelancers, and offer freelancing solutions and creative solutions for dropshippers that have the software, but need help in managing their stores and growing their businesses. This together makes it highly synergic. Thank you. Now we're going to take our next question. And the question comes from the line of Matt Farrell from Piper Sandler. Your line is open. Please ask your question. Matt Farrell Thanks, guys. Impressive free cash flow generation in the quarter, and congrats on completing the buyback. For the $300 million of free cash flow over the next 3 quarters. Should we be thinking about all of that being deployed in some way, just given where your balance sheet is today? And is the preference for continued buybacks or more M&A? Ofer Katz Matt, should I assume you meant three years? $300 million or... Oh, good. So, at first maybe you know something, I don't know. But I think we laid off the capital allocation priorities in the shareholders' letter. Pretty extensive. I will name it now, but again, that's pretty extensive details in the shareholder letter. So the way we see the capital allocation goes from investing product to drive growth. That's something that we've been doing for a while and will continue to do because we think the time is ahead of us. There's a lot of opportunity to capture. The second goes to optimize balance sheet and cash flow generation. I think a quick look into our balance sheet today. So we have a little bit over $700 million of cash and cash equivalent. And this is after we have completed the [$100 million] (ph) buyback. So this $700 million allows us a lot of flexibility and also making sure we have enough liquidity to pay off if needed the convert end of next year. And then if there is an opportunity for the value of the shareholders to do some more share buyback, if price is attractive, we may consider that. And lastly it's M&A. We've been opportunistic in the past and plan to continue and seek for alternatives for us to grow inorganic by M&A. You need to take into consideration that on top of the $700 million, we are generating free cash flow every year, approximately $80 million. As we look forward, we're pretty positive and confident from cash flow standpoint. And I think we intend to strategize our cash usage with the goal of driving steady and consistent free cash flow per share in the next three years. As we mentioned in the prepared remarks with the current line of sight, we believe we can drive CAGR of 14% in free cash flow for the next three years and a similar trajectory for free cash flow per share. Matt Farrell Thanks. And maybe just one more. You mentioned, you know, not competing in the new long-term freelancer category until the recent product announcement. First, is there a way to size how big this opportunity is relative to the part of the market that you've been going after historically? And second, do you have to change your go-to-market strategy at all to compete in this new area with what I would assume to be a different set of competition to some degree? Thanks. Micha Kaufman Yes, so I think, when we look at this -- as we go up market, this opens up the ability to have a significantly larger ticket size project that are by definition more longer term or resemble more long term freelancer hiring. And as a result of that, that has a number of implications. One it allows to increase the top-of-funnel traffic, because it allows us to get into more relevant keywords. As we invest in the profession catalog, it allows us to exist also on keywords that have to do with specific skills and not only on services. And lastly, also on conversion, it provides a way for buyers to search talent and initiate time-based contracts without having full scope and, as a result, get into a more ongoing engagement. These are the types of engagements that Fiverr wasn't a part of. When you think about this competitively and what does it do to the market, we still think that the vast majority of opportunity is offline. It doesn't reside in specific market bases or platforms, but it is actually pretty scarce, widely spread either in directories or in offline ways of engagement. And we think that this is where the opportunity is in bringing that offline activity to the online and this is why it is important for us to invest again to create this opportunity for top-of-funnel relevant keywords to create more opportunity for new business traffic coming into Fiverr. Thank you. Now we're going to take our next question. And the question comes from the line of Marvin Fong from BTIG. Your line is open. Please ask your question. Marvin Fong Hi, good morning. Thanks for taking my questions. Just a couple for me. Just so curious on the volatility fall in June and continuing in July. I know you said it was kind of across the top of funnel, but could you kind of speak to the larger businesses on your platform? I think in the past you've referenced like the TikTok's and Deltas of the world. I mean, the larger organizations are you also seeing this level of volatility or is it isolated to SMB? And then secondly, I know you referenced in your shareholder letter that Promoted Gigs and Seller Plus continue to do well. I'm just wondering if you could just drill a little deeper on that, I think in the past you've given us some growth rates, but anything more you could share just on your view of that in the context of the choppiness we're seeing, freelancers leading into these types of services to grow their businesses even more, that'd be helpful. Thanks so much. Micha Kaufman Thanks, Marvin. That's a good question. So, when we look at our larger customers, that segment is growing faster than the rest. So yes, when we think about macro, macro does influence smaller businesses more. It should be said though, and we called out that, for example, one of the things that were surprising that volatility is that, categories like programming and technology which are always growing were a little bit more volatile during that period of time. And again, I think I called out the number of statistics on professional hiring that I think are troubling and are saying that there is an impact of macro. That said, it is mostly top-of-funnel, meaning, what you see is reduced levels of top-of-funnel traffic. Now this doesn't necessarily touches our existing customers. Actually, if you think about it and you look at cohort behavior, actually we're seeing cohorts behave better than before. And I called that in previous earnings and that hasn't changed. Meaning, that newer cohorts are spending more on their first purchase, first month, first quarter, first year, and we're seeing those trends. So it's less of a volatility of existing customers and those larger customers that work with us, in most cases only extend the scope of work that they do. And yes, it is impacting SMB more than that. I think the second part of your question was about Promoted Gigs and Seller Plus. Yes, they're doing well. And I think I said in the previous earnings, when we gave a little bit more color in the form of actual number of growth, I said that there's a very nice road ahead for continued growth in both of these programs. And that continues to be the case, right? Sellers are very eager to get in. And obviously these are -- in some cases, these are programs that are not open to all of them. The reason why they love using these products is it does create more income. It does create more value, more transparency, more analytics into their business. So we continue to create more ways for them to enjoy. It in Promoted Gigs, increasing real estate, in Seller Plus. In part of the Summer Release, we talk about starting to build a Kickstarter program that would provide more value to actually newer sellers, meaning it will help them start selling much faster and help them grow their business. So there's plenty of road ahead and we're not close to consuming the maximum potential of these programs. Thank you. And the last question for today comes from of Rohit Kulkarni of ROTH Capital Partners. Your line is open. Please ask your question. Rohit Kulkarni Hey, thanks for taking my question. A couple of them. I guess, like, looking ahead, it feels like GAAP profitability is not too far in the future for you guys. Maybe talk about once you turn GAPP profitable, how does that change your philosophy of running the business? I see you already have put out bullish free cash flow generation potential, but it feels that the model brings us to a GAAP profitability by end of this year and every quarter going forward. So we'd love to get your take on that. And then in terms of this June, July trends, I know a lot has been asked and you've shared quite a few things. Perhaps again, asking you guys a hard question, what gives you confidence that this volatility does not linger into August and September? Any leading indicators that you would point us towards? Ofer Katz I'll take the first part on the GAAP. As we usually take and guide on long-term EBITDA and free cash flow, less on GAAP, but we have turned into GAAP profitability already, so that's a good news. And as we look into the future, we anticipate that the gap between the EBITDA and GAAP is going to decrease because of the share-based compensation that we are carrying from 2021. So that within a 12 months ahead of us, what we anticipate is that the share-based compensation is going to be reduced from 18% of revenue as of now to 13%, which is pretty much in the range of the industry. And GAAP EBITDA will grow side-by-side with EBITDA. I think we set the EBITDA target, the long-term target to 2025. We now gave it a timeline of 2027, free cash flow, follow EBITDA. And I think that now that we are GAAP positive, I think we'd see improvement in GAAP income profitability over the next two quarters. Micha Kaufman And the next question about June and July trends. So it should be said, I said that it's hard to call them a trend. There is some volatility, and that volatility is something that the guidance takes into account. It does take into account that it's continuing into July and potentially impacts on the second half of the year. Hence, the updated color around active buyers. At the same time, spend per buyer take rates going up, which we think is going to cover it. And I mean, volatility might be influenced also as you think about how the year will seem to progress on decisions about the interest rates and the outcome of the election in the U.S. So obviously, we're not prophets and it's very hard to know, but since we've taken into the guidance the possibility of this volatility continuing, but the confidence that we have on the spend per buyer and take rate, we believe that we're going to cover it. Thank you, Rohit. Now I would like to hand the conference over to your speaker, Micha Kaufman, for any closing remarks. Micha Kaufman Thank you, Nadia, for moderating the call today, and thank you, everyone, for joining us. We're looking forward to seeing you in person very soon during the quarter. Thanks so much and have a great day. This concludes today's conference call. Thank you for your participation. You may now all disconnect. Have a nice day.

PROS Holdings, Inc. (PRO) Q2 2024 Earnings Call Transcript

PROS Holdings, Inc. (NYSE:PRO) Q2 2024 Earnings Conference Call July 30, 2024 4:45 AM ET Company Participants Belinda Overdeput - Head of IR Andres Reiner - President and CEO Stefan Schulz - CFO Conference Call Participants Parker Lane - Stifel Scott Berg - Needham & Company Nehal Chokshi - Northland Capital Markets Operator Greetings. Welcome to the PROS Holding 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 conference call over to Belinda Overdeput, Senior Director of Investor Relations. Belinda Overdeput Thank you, Operator. Good afternoon, everyone, and thank you for joining us. Our earnings press release, SEC filings, and a replay of today's call can be found on the Investor Relations section of our website at pros.com. Our prepared remarks are also available on our website and will be replaced by the official transcript, which includes participant questions once available. With me on today's call is, Andres Reiner, President and Chief Executive Officer, and Stefan Schulz, Chief Financial Officer. Please note that some of the commentary today will include forward-looking statements, including, without limitation, those about our strategy, future business prospects, and market opportunities, and our financial projections and guidance. Actual results could differ materially from such statements in our forecast. For more information, please refer the risk factors described in our SEC filings. PROS assumes no obligation to update any forward-looking statements to reflect future events or circumstances. As a reminder, during the call, we will discuss non-GAAP metrics. Reconciliations between each non-GAAP measure and the most directly comparable GAAP measure, to the extent available without unreasonable effort, are available in our earnings press release. With that, I'll turn the call over to you, Andres. Andres Reiner Thank you, Belinda. Good afternoon, everyone, and thank you for joining us on today's call. We delivered a solid second quarter, exceeding the high end of our guidance ranges across all metrics. We grew subscription revenue by 14% and total revenue by 8% while achieving significant profitability milestones. Year-to-date, we've delivered a 554% improvement in adjusted EBITDA, and a 112% improvement in free cash flow year-over-year, with both metrics yielding positive first half results despite seasonally high expenses. In Q2, we also achieved our long-term goal of 80% non-GAAP subscription gross margin. I'm extremely proud of our team for building the market-leading profit and revenue optimization platform, which drives immense value for customers powering 4.1 trillion transactions a year while delivering expanded subscription gross margins. Now, in the second half, we're being cautious with respect to our travel business. Typically, the second half is seasonally strong for airline bookings, and that certainly was the case in 2023. Despite enjoying strong passenger demand, airlines continue to face operational cost and supply chain challenges. These challenges impact deal approval processes and length in sale cycles. As a result, we're assuming our travel bookings will be down year-over-year, impacting our outlook for 2024, which Stefan will cover in more detail We remain fully committed to achieving our long-term goal of becoming a Rule of 40 Company. We've made considerable progress, and our confidence in achieving our long-term goal is strong. Here's what fuels our conviction. First, the value proposition of the PROS platform is more relevant than ever, and we see increasingly favorable competitive dynamics, both driving continued strong deal volumes and win rates. Our clear value proposition is why more customers are prioritizing PROS as a top initiative supported by their boards as a means for driving revenue growth and margin improvement, fueling strong expansion activity. Second, we continue to invest in innovation to drive faster activation of our market-leading platform and accelerate time to value, bolstering our land, realize, and expand strategy. I will share a few examples from Q2 that highlight these points, starting with new customer wins. A top three global medical devices company selected the PROS platform in Q2 to activate Smart CPQ and smart price optimization. With goals to accelerate sales and drive increased win rates, the company chose PROS as their strategic partner to help them deliver on their growth objectives. The initial regional land is the beginning of a partnership that can span over 100 countries around the globe. Dynata, a leading first-party data solution platform, selected the PROS platform to activate Smart CPQ, empowering their global sales team to accelerate time to grow with winning offers. Dynata chose PROS for the depth and breadth of her platform to support their direct sales in future expansion of their e-commerce channel Now to expansions. A few quarters ago, I shared Ingredion's continued success with PROS, highlighting multiple regional expansions of our platform. We're proud to announce that as of Q2, Ingredion has decided to expand the PROS platform globally, underscoring the value they drive with our solution. We're also expanding the PROS platform across VFS global operations. As the world's largest chemical producer, VFS uses our platform to drive pricing and sales excellence in the face of inflation and supply chain volatility, making PROS the strategic priority for global deployment. Hertz expanded their use of the PROS platform by activating capacity-aware price optimization across all North America locations. This solution uses patent-pending technology powered by neural network AI to assess the opportunity cost of diminishing supply against demand in real time. This allows Hertz to set real-time prices based on fleet capacity and fluctuating demand, enabling them to win more business and drive a better customer experience. Philippine Airlines, a PROS customer of over 20 years, expanded their use of the PROS platform by choosing to activate Group Sales Optimizer. With GSO, Philippine Airlines will power a digital sales motion for group travel across channels, driving increased conversion with a frictionless end-to-end customer experience. Innovation has always been central to our growth strategy and core to who we are. We released a new generative AI data transformation solution to power seamless data integration between third-party systems and the PROS platform, making our AI innovations even easier and faster to activate. This is just one of the many AI innovations we showcase at a record-breaking outperforming conference in May, which had its largest in-person turnout ever. The event featured 60 customer speakers who shared remarkable success stories with PROS, highlighting how these innovations are driving significant business outcomes for their organizations. Finally, Todd McNabb, our Chief Revenue Officer, has unified our B2B and travel go-to-market teams. We're building a centralized revenue engine to drive a unified go-to-market across all phases of the customer journey, from demand generation to customer success. This change will drive further productivity, rigor, and skill to strengthen the flywheel that is our land, realize, and expand strategy. I would like to thank our incredible global team for their passion and dedication to PROS, our customers, and our communities. I would also like to thank our customers, partners, and shareholders for their ongoing supportive PROS. With that, I will turn the call over to Stefan to cover financial performance and outlook. Stefan Schulz Thank you, Andres, and good afternoon everyone. A key pillar to our strategy is becoming more efficient as an organization. This is a core component to attaining the profitability range of our Rule of 40 goal, so I wanted to start by discussing the progress we have made over the last two years. Comparing our results from two years ago, we have grown our total revenues by 10% per year while improving our non-GAAP subscription margins by 300 basis points and our non-GAAP gross margins by 400 basis points. We have also reduced our operating expenses by a rate of 1% per year during that span of time, resulting in a 1,700 basis point improvement in our adjusted EBITDA margin. We have become more efficient in every part of our company, and we have new initiatives underway to drive even more efficiencies in the future. Now we'll share some more details on our second quarter results. Subscription revenue was $65.6 million, up 14% year-over-year, and total revenue was $82 million, up 8% year-over-year, both exceeding guidance. Our second quarter recurring revenue was 84% of total revenue, and our trailing 12-month gross revenue retention rate continues to be 93% or better. Services revenue was $13 million, down 3% year-over-year. This was slightly below our expectations because a higher portion of our subscription bookings were related to expansions, which require less services than subscription bookings from new logos. Calculated billings in the second quarter increased 10% year-over-year, and 8% for the trailing 12 months. Looking forward, we expect calculated billings to follow a similar trend to last year, where Q3 growth is expected to be at the lowest point in the year, and Q4 to be stronger. For the year, we expect the growth rate for calculated billings to approximate total revenue growth. As Andres highlighted, our non-GAAP subscription margin increased to 80% in the second quarter, an improvement of over 160 basis points year-over-year, and an all-time high. To put this achievement into perspective, we first targeted a subscription gross margin goal of 78% nine years ago. Given the sophistication of our AI and the data volumes we process, we really didn't see attaining 80% subscription margins at the time. As our engineering and operations team improved the efficiency of our cloud services, we eventually saw a path to an 80% subscription margin and set that as a long-term goal at our Analyst Day 14 months ago. Now, we have achieved this updated goal of 80% earlier than planned, and it is a true testament to our engineering team's innovation and hard work that we have now achieved this milestone. Our overall non-GAAP gross margin was 67% in the second quarter, an improvement of over 210 basis points year-over-year. We generated adjusted EBITDA of $5.2 million in the second quarter, significantly exceeding guidance and improving more than $5 million over last year. We generated free cash flow of $6.2 million in the second quarter, an improvement of nearly 200% year-over-year, and delivered positive free cash flow during the first half of the year for the first time as a SaaS company. From a balance sheet perspective, we exited the second quarter with $149.1 million in cash and investments, net of the settlement of the remaining $21.7 million of our 2024 convertible notes. Our second quarter non-GAAP earnings per share was $0.07 per share, also exceeding guidance. Now, turning to guidance. As Andres mentioned, we believe the operational challenges airlines are facing creates some risk for us in the second half. Additionally, the stronger than anticipated expansion activity I noted earlier had some impact to our services and total revenue because of the lower attached service revenue that typically comes from expansions. Accordingly, we believe it is prudent to adjust some components of our guidance. So for the full year, we are revising our guidance in three areas. We anticipate total revenue of between $329 million and $331 million, representing 9% growth at the midpoint, because we are now anticipating lower services revenue from what was implied in our previous guidance. We are anticipating free cash flow of between $20 million and $24 million, representing a 94% improvement year-over-year at the midpoint. And we now expect subscription ARR of between $280 million and $284 million, representing 9% growth at the midpoint. We are reiterating the previous guidance range for subscription revenue of between $263.5 million and $265.5 million, representing 13% growth at the midpoint, and we are raising our guidance for adjusted EBITDA of between $21 million and $24 million, representing a 275% improvement at the midpoint. Shifting to guidance for the third quarter, we expect subscription revenue to be in the range of between $65.8 million and $66.3 million, representing 10% growth at the midpoint. We expect total revenue to be in the range of between $81.5 million and $82.5 million, representing 6% growth at the midpoint. We expect adjusted EBITDA of between $6.5 million and $7.5 million, and using a non-GAAP estimated tax rate of 22%, we anticipate third quarter non-GAAP earnings per share at $0.08 to $0.10 per share, based on an estimated 47.8 million diluted weighted average shares outstanding. I want to echo Andres' comments in saying that we continue to have conviction in achieving the ranges for total revenue growth and free cash flow margin towards our long-term goal of being a Rule of 40 Company. We've made considerable progress since we set this goal a little over a year ago, and we are confident that we will continue to make progress and ultimately reach our goal. Although we also acknowledge that the current conditions in the airline space will likely push the achievement of this goal by approximately one year. In closing, I would like to thank our global team and our customers for their continued support of PROS. We also thank you, our shareholders, for your support of PROS, and we look forward to speaking with you at our upcoming events. I will now turn the call back over to the operator for questions. Operator? Question-and-Answer Session Operator Thank you. At this time, we will be conducting a question and answer session. [Operator Instructions] Our first question comes from the line of Parker Lane with Stifel. Please proceed with your question. Parker Lane All right. Thanks for taking the question here. Andres, I was wondering if you could go into a bit more detail on what you're hearing in the conversations you're having with the travel customers about the challenges they're facing. More importantly, when do you anticipate and what are they thinking about the potential for a timeline to put some of those challenges behind them? Andres Reiner Great question, Parker. I would tell you, look, we're working very close with our airline customers. In fact, myself and the executive team had numerous meetings with CEOs of Top Airlines and executive teams. What we're seeing right now is they are wanting to get their operational back in line. And I think that is their focus area. We're also working with them to help support in some of the changes they're making, as well as provide areas where we can help them drive value with smaller investment and little team support to activate. So what I would tell you is we're leaning in areas, whether it be staff, continuous pricing, willingness to pay off for marketing, components of our platform that we can activate to get deals started while we're supporting them through these operational challenges that they face in supporting their teams in the process. I can tell you we're as close as we've ever been with the airline industry and we've always leaned in to support them. And I feel that the guidance we're providing is consistent with what we believe. Definitely in Q3, there's going to be an impact due to that. But our approach, like always, is then in times when the airline industry has had challenges, is to lean in, support them, and help them come out stronger, and we're consistent and convinced that that's going to happen. Parker Lane Got it. That makes sense. And then, Stefan, maybe one for you. I see sales and marketing ticked up a little bit quarter-over-quarter. You also talked about the unification of the go-to-market of travel and B2B. Just wondering in the initial stages here what your thoughts are on the potential efficiencies that unification can drive in both the near term and long term? Stefan Schulz Yes, Parker, the tick up in the second quarter was more to do with the marketing activities. We had our outperform event and that is really what drove up the cost. I would tell you that we do and continue to expect to see efficiency benefits that come as a result of, to your point, bringing the travel organization and the B2B organization to be more along of one organization. So that said, I think, you'll continue to see that line item perform well. I think it might be slightly up as we go through the rest of the year as you compare to last year, primarily because of other marketing investments we want to make in order to continue to improve our funnel and our pipeline. Parker Lane Understood. Thanks again. Stefan Schulz Thank you. Operator Thank you. Our next question comes from the line of Scott Berg with Needham & Company. Please proceed with your question. Scott Berg Hi, everyone. Thanks for taking my questions. Stefan, the first question I have for you is on, and I know it's way too early, but thinking about revenue growth in the next year in the calendar '25, if you exit with an ARR growth rate here of, we'll call it 9% or 10% here by the end of the year, given your current guidance, would that drive a high single digit 10% growth here in your subscription revenues next year or why would that not be the right starting point for us to start getting comfortable with? Thanks. Andres Reiner Yes. So I guess first of all, I'm not going to make a comment really on '25 just yet. We're not through our planning process to go through that. But second, Scott, what I will say is that, you know, when we look at our subscription ARR metric, you know, that is one leading factor that can dictate what the revenue is going to be. The other part is, you know, what happens from the, you know, in quarter bookings. And so I think to Parker's question earlier, you know, the things that we're doing to respond to the airline situation, things that we're doing to, you know, sell some ancillary products that actually help improve their, their go to market, there's things we can be doing to respond to the situation that I think can offset what you might see from a starting point, which would be our subscription ARR. So we are not at this point conceding to a growth rate that would be in the upper single digits for next year. However, we're also not prepared to give you what a growth rate would might look like. But I think there's some things we can be doing to respond to this environment that could give us a better answer than that starting. Scott Berg Got it. Helpful. And then following up on Stefan's last comment, I don't know if yourself or Andres want to tackle this one in particular, but pushing your Rule of 40 goal from what I believe was calendar '26 now into '27, if you're pushing it for a year is how do we think about the components or the details of that push? Will that be more related to probably the revenue growth opportunity given what's going on in the travel segment right now? Or is there some component around the profitability that might leg as well? Thank you. Andres Reiner I'll give you, Scott my perspective. To me, the components aren't changing with what we had said, 16% to 21% growth on revenue and 19% to 24% on free cash flow. I can tell you, look, we're very excited about the market opportunity and how we're executing or land realize expand strategy. We always focus on deal volumes, and we're continuing to focus on consistency. I can tell you on the B2B side, our sales cycles continue to improve and improve 15% year-to-date, and if you remember last year, improved 30%. So we're continuing to drive more rigor. I'm very pleased with Todd and the changes he's making to unify the organization. And it's all about continuing to execute on our land realize expand strategy and build a flywheel effect. And I believe that, I think that's going to have a big payoff as we continue to execute on the strategy. And on travel, our ASPs are down a little bit over 40%. It's what we expect because of this. But we are trying to land and get small lands that can build growth opportunities next year and beyond. So, like we are rallying around this to drive the best outcome possible for our customers and for our business. So we're all in this. We're not letting go of growth. We're just trying to continue to help support them and be cognizant of the areas they need to improve, but support them to drive better business outcomes and growth for us in the future. Stefan Schulz Yes, I think just to add to that, there's a couple ways to think about how we can achieve the Rule of 40. I mean, the comeback year, so to speak, that happens once we're through, the challenges that we've referenced could be a nice way to fast start an accelerated revenue growth rate. But that's not how we want to achieve a Rule of 40. We want to achieve a Rule of 40 and have it be sustainable. So to Andres's point, we're putting in the foundation work that basically shows that we could be at 16% to 21% growth rate on the revenue side, not just for one year, but for many years to come. And then also have that working off of a platform that can be generating 19% to 24% free cash flow margin. So the reason we went ahead and decided to push it the year is because we think that's really what it's going to take for us to find that consistent level of performance so that you can count on us to be delivering a Rule of 40, not just for one year, but multiple years. Scott Berg Understood. Thank you for taking my questions. Andres Reiner Thank you. Operator Thank you. Our next question comes from the line of Patrick Scholes with Baird. Please proceed with your question. Patrick Scholes Hey, guys. Yes, I appreciate the time today. Maybe first just on the Microsoft partnership. Can you just talk a little bit more about how that partnership has progressed? I think at the Outperform event earlier this year, there was a lot of customer interest in this. Just curious how that has translated into pipeline build looking into the second half of this year into 2025 as well? Andres Reiner Yes. So overall, look, we're very pleased with the Microsoft partnership. We just won Partner of the Year for the second time. In our innovations, and my belief in the areas of the sales scope pilot, this is the next generation of sales technology. We're both excited about the opportunity ahead. It's an early stage of sales adopting generative AI technology to power the sales motion. But where we're innovating, we're very excited. And I would tell you from a collaboration on deals on the pipeline, we continue to collaborate on many opportunities and work jointly on this opportunity. So overall, we feel very good. As you saw Outperform, we're very excited about Outperform. I had a thousand registrants, 60 customer speakers, and I could tell you that the feedback from it was very, very positive. And we generated more than double the opportunities this year at Outperform compared to a year ago. Some of these innovations with Microsoft played into that. So overall, we feel very good. Patrick Scholes Okay. That's helpful. Maybe a quick follow-up to you on the macro and appreciate all the commentary just on the updated travel expectations, but from a broader viewpoint, has anything changed from a customer's willingness to sign deals this quarter relative to last quarter, maybe more generally outside of travel? How has the demand environment been relative to last quarter? Andres Reiner Yes, great question, Patrick. I would tell you, look, the environment continues to be a very difficult selling environment. It's not easy to get deals through. I think our team has been very focused on ensuring that we can sell fast time to value, quantified ROI. We're selling at the right level because right now companies are taking a few bets that they're investing on. So I would tell you the environment continues to be very, very hard selling environment. Our team is doing the best to drive the best outcomes. I think in the B2B side, we're seeing the average deal size remain consistent with last year. So we're not going in and trying to reduce. We're selling in more consistent motion. And I would tell you, we're doing very well in expansions. I would say that's a highlight. We're seeing -- we adopted the platform strategy a couple of years ago. We're seeing that play into last quarter. A lot more customers expanding. And those expansions, because we're leveraging the platform, they require little to no services to activate, which is a great story for customers because they get more value. They get value faster. And it allows them to move on that journey to go from starting in one division to getting to global. And the Ingredion is an example. And we have VSF working on that as well. So overall, I believe that land realize, expand strategies is definitely working. But it is a difficult selling environment. No doubt about that. Patrick Scholes Great. I appreciate the call. Thanks for taking the questions. Andres Reiner Thank you. Operator Thank you. Our next question comes from the line of Jason Celino with KeyBanc Capital Market. Please proceed with your question. Jason Celino Great. Thanks for taking my questions today. Maybe on the travel side, just curious when you started to see some of this extra cautiousness, I know there was a security software vendor that caused a lot of trouble for some of these airline travel companies recently. Wondering if that had anything to do with maybe reprioritization of some of their purchases? Andres Reiner Yes, great question. I would say, obviously, the crowd site incident had big to do with it. That had a pretty broad impact to the travel industry. Many took days to recover from that. And as you would imagine, they have a lot of focus on getting back to operational. But I would tell you, late in the quarter and into the beginning of this quarter is when we started to see that impact. And that probably was what compounded the effect. Jason Celino Okay. No, that's helpful. And then more of just like an overarching question just on the guidance for the year. We obviously have the U.S. election coming up. I'm curious how you've built that into the guide. Or even if elections in prior years have had an impact on customer decision making, but I thought I'd ask, given kind of the Q4 dynamics? Stefan Schulz Yes, so I've only been here for two previous election cycles. And I can't recall any sort of dynamic that occurred as a result of anything. It's a good question, because I know there's a lot of discussion and topic around it. But we really haven't seen an impact from it in terms of how customers are looking to invest. So we didn't factor anything one way or the other into our guidance as it relates to the election. Jason Celino Okay, perfect. Thanks, Stefan. Operator Thank you. Our next question comes from the line of Brian Schwartz with Oppenheimer. Please proceed with your question. Brian Schwartz Yes, hi. Thanks for taking my questions this afternoon. Andres, I just wanted to ask you what you're saying in terms of average sales cycle duration times in the B2B business in Q2 versus Q1, if you saw any downtick or feel pretty consistent in tough environment out there for new logos? Andres Reiner Great question. So we've told you overall B2B sales cycle times have improved by 15% year-to-date. And I would say its consistent Q1 and Q2. We're seeing that improvement. And I would say that's on -- I think the rigor on execution. And I think the consistency in our motion, I think it's helping to improve that we're focused, I wouldn't say we've declared victory, we're still focused on driving even more improvement to that in the changes that Todd and I are making jointly across the organization, unifying the organization. But overall, we're pleased with those improvements. Brian Schwartz Follow up question I had for Stefan. It also was on the guidance and just thinking about Q4. You know, the implied subscription revenue growth guidance for Q4 is for re-acceleration even when you normalize comps. Is there something that you're seeing either in your pipeline or you're hearing from customers that is giving you the confidence to guide for the subscription business to re accelerate as you're exiting the year? Thanks. Stefan Schulz Yes, Brian. So, when you look at our second half of subscription revenue, and in Q3, specifically we're guiding to a lower growth rate. And that was planned all along. Because we knew we had a much higher subscription number a year ago because of some accelerated recognitions that we benefited from a year ago. So that dip that you're seeing in Q3 was we expected to see a dip all along, and then, kind of returning back to a better growth rate in the in the fourth quarter. So we are certainly expecting that. And as you pointed out, we are guiding to that. I would tell you that what's driving the sequential increase between Q3 and Q4 is a little bit of what we have built into the backlog of deals that were expected to be starting the recognition, but also the revenue from new bookings. So even though we've adjusted our booking forecast down mostly from the second half, we still are expecting to see a good second half to the year relative to the full year. In other words, we still expect to see more bookings in the second half than we did the first half. So that is a part of the guidance. And while we feel like Q4 can see a bit of an increase over Q3. Brian Schwartz And then if I could just squeeze one more in, Stefan, on the good expansions activity that you had in Q2. Was any of that impacted at all by early renewals? Did you have customers kind of coming in and buying more ahead of their renewal season or was mostly just add on sales or expansion activities with headcount? Thanks again for taking my questions. Stefan Schulz Yes, Brian, we see that from time to time, but it's not a predominant part of our renewals. So I would say we did not see anything abnormal in the second quarter. From that perspective, most of our expansions relate to that had -- that were attached to renewals were pretty much on time. We may have had a small number that were a little early, but that's pretty normal. Operator Thank you. Our next question comes from the line of Jeff Van Reeve with Craig-Hallum Capital Group. Please proceed with your question. Jeff Van Reeve Great. Thanks. Thanks for taking my questions. I've got a couple. First, on the B2B enterprise side. Did the bookings on B2B hit expectations this quarter? Andres Reiner I would say the bookings were pleased with the bookings on the B2B side. Jeff Van Reeve And so I guess in terms of the forward guide, was there any change to the implicit B2B bookings expectations? Andres Reiner No, I would say all the change in the forward guide is, it's all due to travel, so not expecting things. Yes. Jeff Van Reeve Got it. Got it. Very helpful. And then on the Gen 4 product, I'm kind of curious more, to hear a bit more about the experience you've seen out in the marketplace specifically, it's got a lot of advantages, takes less data to get started, which would seem to give it more broader applicability in terms of vertical industries. Have you seen it having enough impact that it's opening up prior markets that you were not able to get at with the older product? Andres Reiner Look, I would tell you in general, we have so much opportunity within the industries we're in that for us is going deep within the industry. We could apply our technology to all, but it's really about the industries we serve going deeper and deeper. And we've been very, very focused on time to value and reducing that dramatically. And my belief long-term customers aren't going to want to pay much for activation. And we've been innovating in our product to drive these very fast activation. And this is just one of the innovations towards that focus area. And it can -- the beauty of this innovation, it can help us with the industries we're in. It can help us expand into new industries. And the beauty of our platform is the data model is dynamic. We could go after any industry we wanted to go and expand, but we're already in about 40 industries on the B2B side. So we have plenty of time to go after and go deep. So for us right now, it's how do we activate those particular industries even faster? Jeff Van Reeve Got it. Maybe if I could just sneak one last in as you're pushing more and more into the land and expand opportunities. Can you share anything with respect to the B2B side and what a typical size of a land looks like now versus maybe a year ago? Just even, I don't know, broadly speaking, but love to get a sense of that trade-off quantity and price and how that's playing. Andres Reiner Yes. So I would tell you that the average deal size on B2B last year to this year remains consistent. It's in the 200K range. And that's kind of the zone. Three to four years ago, we executed on our platform strategy and our goal was to get that to that 200K range. And that to me is a great place to land and drive fast expansion. So I would say, I would expect that to remain consistent. And I would tell you, year to-date, its exactly the same as it was last year. Jeff Van Reeve Okay. Great. Thank you. Andres Reiner Thank you. Operator Thank you. Our next question comes from the line of Nehal Chokshi with Northland Capital Markets. Please proceed with your question. Nehal Chokshi Yes. Thank you. And personally, it sounds like you did have less lands than expected, albeit more expansions than expected. A, is that correct? Stefan Schulz On the B2B side, that is correct. Nehal Chokshi Okay. And why is it that your less than expected lands on the B2B side? Andres Reiner I would tell you, look, any particular quarter, you're going to see changes between land and expand depending on the pipeline you're executing. And I would tell you a lot of that has to do with the focus on the lands that we had. And those are coming up for expansions. And we executed on those. I wouldn't read too much into it. I would say that as we've discussed, this is a difficult macro environment to sell in. And where you've achieved value, it's obviously easier to drive expansions because they've seen quantified value. And in many cases, most customers are having initiatives around driving margin uplift and efficiency in the organization. And we're in incredible technologies to help do that. So where they've already seen that it's helping them scale, it's helping them drive margin improvement. They want to accelerate that. And we're allocating resources to go selling to those accounts. Nehal Chokshi Okay. And then Stefan, I still don't quite get why we are guiding a higher bid to lower free cash flow guidance in the context of the lower 2H '24 travel booking expectations? Stefan Schulz Yes. So it's really the timing between when we get the profit relative to when we get the benefits of the cash. I mean, some of the EBITDA improvement that's occurring in the guidance range that we provided for this year relates to items such as some incentive payments that won't be realized until 2025. So you'll see the EBITDA improvement, but you won't see the free cash flow impact for another few months. So that's one example. Nehal Chokshi Okay. All right. Thank you. Andres Reiner Thank you. Operator Thank you. Our next question comes from the line of Victor Cheng with Bank of America. Please proceed with your question. Victor Cheng Hi, everyone. Thanks for taking my questions. Most of them has been asked, but two, if I may. Firstly, on new versus existing, I remember previously it's close to a 50-50 split. Can you give us some more color on what the split is right now and across B2B and B2C? I remember previously B2B had more new logos. And with that in mind as well, not just for Q2, but going forward with the full year guidance, are you still expecting a lower split of new versus existing? Andres Reiner Yes. So right now we're seeing a higher percentage of existing than new. I would say for the back half, we see strong new opportunities. So I wouldn't expect that to maintain. But I would say this year we're expecting where we typically are in that 50-50 range, we're definitely expecting probably closer to a 40-60 split between new and existing versus a 50-50 split. Victor Cheng Got it. Thank you. And maybe one regarding - Andres Reiner By the way, there's still a lot of, I mean, we didn't go into it, but there's a lot of great lands and net new customers that we landed both on the travel and B2B. And we highlighted just a few in my prepared remarks, but there's incredible lands and some are really like a top three medical device companies, some are very incredible lands that we're having. So we're very happy with the lands that we're getting. Victor Cheng Understood, very clear. And maybe the other one is any comments you can make regarding FTC's kind of study on the market data usage. And do you think it will limit maybe how your customers can use their clients' data and kind of potentially limit the value proposition in the long term? Andres Reiner Yes. At this point, I would say it's too early. We see this as -- we're just in the process of responding to the FTC and we see them more as trying to understand the market. From more perspective, we've always had clear data segregation between customers. So no data from a customer can help the algorithm or train the algorithm for another customer. And that's been from the very beginning. The other area that their focus is in the personal identifiable data and we don't use PIA to help do our pricing algorithms. So for us right now, I don't see any broad implications. This is for us is just the FTC learning in trying to understand this market. Victor Cheng Understood. Thank you. Andres Reiner Thank you. Operator Thank you. Ladies and gentlemen, we have reached the end of the question-and-answer session. I'd like to turn the call back to Belinda Overdeput for closing remarks. Belinda Overdeput Thank you for listening to today's call. We look forward to speaking with you at conferences and events this quarter. We will be attending the KeyBanc Capital Markets Technology Leadership Forum on August 6th in Vail, the Virtual Oppenheimer Technology Internet and Communications Conference on August 13th, and the Wolf Research TMT Conference on September 10th in San Francisco. If you have any questions following today's call, please contact us at [email protected]. Thank you and goodbye.

Earnings call: Leidos reported a record quarter with a 7.7% YoY increase in revenue By Investing.com

Leidos Holdings , Inc. (NYSE: NYSE:LDOS) has announced its financial results for the second quarter of fiscal year 2024, demonstrating substantial growth and profitability. The company reported a record quarter with a 7.7% year-over-year increase in revenue to $4.13 billion, and a significant rise in adjusted EBITDA, which reached $559 million, marking a 33% increase from the previous year. The adjusted EBITDA margin also hit a record at 13.5%. Leidos, an information technology, engineering, and science solutions and services leader, has raised its full-year guidance following these strong results. The company's successful execution of its strategy has led to a high level of customer satisfaction and has positioned it well for future growth. Key Takeaways Company Outlook Bearish Highlights Bullish Highlights Misses Q&A Highlights Leidos' second-quarter performance underscores the company's strategic focus on driving current financial performance while building for future success. With a robust pipeline and a commitment to innovation and customer-centricity, Leidos is well-positioned to continue its growth trajectory in the dynamic sectors of information technology and engineering services. InvestingPro Insights Leidos Holdings, Inc. (NYSE: LDOS) has not only delivered impressive financial results for the second quarter of fiscal year 2024 but also exhibits a strong investment profile according to InvestingPro metrics and tips. Here are some key insights: InvestingPro Data shows that Leidos has a market capitalization of $20.68 billion, reflecting its significant presence in the industry. The company's P/E ratio stands at a high 62.52, which suggests investors may be expecting high earnings growth in the future. This aligns with the adjusted P/E ratio for the last twelve months as of Q1 2024, which is at 23.75, indicating a more favorable earnings outlook when considering adjustments. Additionally, the company has experienced a 7.62% revenue growth over the last twelve months as of Q1 2024, which supports the strong performance outlined in the quarterly report. Among the several InvestingPro Tips, two are particularly relevant to the article's context: 1. Leidos has raised its dividend for 5 consecutive years and has maintained dividend payments for 13 consecutive years, showcasing a commitment to returning value to shareholders. This is an important factor for investors seeking stable income through dividends. 2. The company is anticipated to grow its net income this year, which corroborates the raised full-year guidance and reflects confidence in Leidos's ability to capitalize on its strategic initiatives and market opportunities. Investors seeking a deeper analysis of Leidos's financial health and future prospects can find additional tips on InvestingPro, with a total of 13 tips available. Use coupon code PRONEWS24 to get up to 10% off a yearly Pro and a yearly or biyearly Pro+ subscription, further empowering your investment decisions with comprehensive data and expert insights. Full transcript - Leidos Holdings (LDOS) Q2 2024: Operator: Greetings. Welcome to Leidos' Second Quarter 2024 Earnings Conference Call. At this time, all participants are in a listen-only mode. A brief question-and-answer session will follow the formal presentation. Please note, this conference is being recorded. At this time, I'll turn the conference over to Stuart Davis from Investor Relations. Stuart, you may begin. Stuart Davis: Thank you, operator, and good morning, everyone. I'd like to welcome you to our second quarter fiscal year 2024 earnings conference call. Joining me today are Tom Bell, our CEO, and Chris Cage, our Chief Financial Officer. Today's call is being webcast on the Investor Relations portion of our website, where you'll also find the earnings release and supplemental financial presentation slides that we'll use during today's call. Turning to Slide 2 of the presentation, today's discussion contains forward-looking statements based on the environment as we currently see it, and as such, includes risks and uncertainties. Please refer to our press release for more information on the specific risk factors that could cause actual results to differ materially. Finally, as shown on Slide 3, during the call, we'll discuss GAAP and non-GAAP financial measures. A reconciliation between the two is included in today's press release and presentation slides. With that, I'll turn the call over to Tom Bell, who will begin on Slide 4. Tom Bell: Thank you, Stuart, and good morning, everyone. It's great to be with you all again today to report a record quarter for Leidos. In this quarter, organic growth remained strong, achieving a record adjusted EBITDA margin of 13.5%. Year-to-date, we've delivered industry-leading profitable growth, with adjusted diluted EPS 50% higher than last year. The team is doing an excellent job converting our earnings into cash. In turn, this has allowed us to continue to deploy capital to grow shareholder value per our plan. We're now halfway through our commitment to repurchase $500 million worth of shares this year. I'm also proud of the fact that this robust first half of 2024 allows us to once again raise guidance for the full year. Chris will give you a complete update on our financials and our guidance later in the call. One year ago, on my first call with you all, I laid out four focus areas to begin Leidos' journey to best-in-class performance. Instilling in Leidos a "Promises Made, Promises Kept" culture, sharpening our strategy, improving the performance of previous acquisitions, and enhancing our ability to win new business. I'd like to take this opportunity to update you on the meaningful progress we're making in these areas. I see this progress as foundational to putting ourselves in a great position to execute our forthcoming Leidos North Star strategy. First, our team has fully embraced a "Promises Made, Promises Kept" philosophy. As part of this, we've made a firm commitment to each other to drive operational improvement, profitable growth and robust cash conversion. The evidence of this culture taking hold is clearly visible in the 12-month trend of our results, and our second quarter results, summarized earlier, that are simply our best yet. Our currently strong and strengthening balance sheet puts us in an excellent position to continue to allocate capital prudently over time to grow shareholder value. Further share repurchases this year are possible, but at the same time, I must say that our new North Star strategy work is beginning to bring into focus exciting and compelling growth opportunities potentially worthy of investment. This brings me to that second focus area, creating our new North Star strategy. While we continue to deliver robust in-year program execution, we are also aggressively prosecuting our year of deep strategic thinking. And the energy and insights that are beginning to come into focus because of our purposeful strategy process are very intriguing. We've now completed work on the Leidos proprietary hypothesis of the future, our own exclusive prediction of the challenges our customers will face, the solutions those challenges will require, and the technologies we must create and harnessed to best differentiate our solutions for our customers. Informed by our hypothesis of the future, we're now halfway through crafting a new business strategy for Leidos. This strategy will both leverage and enhance our current core businesses and uniquely position us for outstanding success in the future we foresee. One clear component of our strategy will remain our focus on technical differentiators, our golden bolts. Technological innovation is and will remain a cornerstone of Leidos. And our enterprise-wide technology investments are now more than 1% of total revenue and growing. At our recent Investor Technology Day, we went in-depth on one of those golden bolts, Trusted Mission AI. Those of you who were able to join us witnessed firsthand our brilliant team in action, demonstrating how we use Trusted Mission AI to drive productive disruption across our customers' missions. We believe that when it comes to AI, the mission is the market. So, everything we do as the number one provider of IT to the federal government and the number eight US defense contractor is an opportunity to exploit and deploy Trusted Mission AI for our customers' mission benefit. Another area of proactive investment for us remains cybersecurity. For instance, we've been investing in Zero Trust for years before there was a requirement for it to be adopted by federal agencies. As a result, over the last three years, we've received more than $5 billion of awards that cite our Zero Trust methodology as a differentiated strength. We're currently pioneering the application of quantum technologies to enable highly secure networks. We're executing contract R&D for DARPA in this area and investing in post-quantum encryption technologies and solutions. These will ensure our customers can rapidly respond to future developments in quantum computing. These examples give you some understanding of our forward-looking approach to the market and our track record of investing ahead of demand. Third, we're on track to unlock the strategic value from the large acquisitions we made in 2020 and 2021, specifically Dynetics in security, detection and automation. On Dynetics, we have doubled down on three specific areas, each of these now on a robust positive trajectory. In satellite payloads, we're a key supplier to the Space Development Agency's wide-field-of-view sensor program within its proliferated warfighting space architecture. We have delivered all our payloads for Tranche 0, and those payloads were the first ones in low-earth orbit providing SDA actual on-orbit imagery. In addition, we remain on track to deliver our Tranche 1 payloads in early 2025. And we are teamed with Sierra Space to be their payload provider on their Tranche 2 birds. The Space Development Agency has recently issued their RFI for Tranche 3. So in sum, we believe our current comprehensive role on all three existing tranches and our current actual mission performance in space position us well to continue to deliver for this critical and expanding mission. On force protection, we've delivered 14 IFPC Enduring Shield prototypes, which are successfully working their way through government testing. The Army recognizes this system's unrivaled air defense capability, and we expect to receive awards soon to begin low-rate production in 2025 and full-rate production in 2026. And in hypersonics, the United States continues to progress in developing and fielding hypersonic weapons. Leidos is supporting this progress by developing -- excuse me, delivering technology advances through our Common-Hypersonic Glide Body and MACH-TB programs. These programs play a critical role in accelerating the pace and scale at which we can produce, test, assess, advance and field our nation's hypersonic capabilities. We remain on track for our Common-Hypersonic Glide Body and thermal protection systems delivery. And all in all, we feel quite positive about this robust pipeline of opportunities in hypersonics. So, 2024 maintains its promise to be the good year for the maturation of these programs. And we're also seeing our focus here translate into better financial performance. Our Defense Systems profitability was double-digits in the quarter, our first time at that level of performance from as far back as we recast financials in the new organizational structure. Turning to security products, the SD&A acquisition is now fully integrated into our SES business area. Though challenges remain, SES is on sound footing because of the swift actions of our new management team that they took last year. We have focused our efforts and investments in product lines and geographies that make the most sense for Leidos and therefore, our shareholders. Our new Charleston manufacturing facility is up and operational, and we're performing better against our service-level agreements with our customers. We've had solid bookings this year and more consistent deliveries of large border solutions. As a result, SES is ahead of plan for revenue and earnings for the quarter and the year. SES revenues are up 11% year-to-date and we've achieved almost 90% of last year's non-GAAP profit in the first two quarters of 2024 alone. A common theme of this improved acquisition performance is the new organizational structure, which brings better alignment of sector resources and new leadership with an increased emphasis on execution and Promises Made, Promises Kept. Fourth, we continue to make significant progress to enhance our business capture performance and backlog quality. We've achieved net bookings of $4 billion this quarter with a heavy emphasis on cyber and dig-mod awards for a book-to-bill ratio of 1.0. We also have nearly $3 billion of awards currently under protest. We ended the quarter with total backlog of $36.5 billion, including $8 billion of funded backlog. While this quarter's performance adequately supports our 2024 growth commitments, we are not at all satisfied, and our growth teams have been working diligently to reignite our winning ways here at Leidos and do much better on top-line growth soon. An element of this is strengthening our customer-centric framework of account management. Over the past six months, we've hired dozens of key account managers and frontline growth leaders, each with deep mission and customer expertise in areas of strategic importance. Each of our account managers have a frontline obsession and seamlessly integrate across both our P&Ls and our office of technology to ensure we couple best-in-class teams with best-in-class technical solutions. Two examples which illustrate this point are our recent hires for INDOPACOM and AUKUS. Because of their respective hard work in very short order, we've won strategic awards to support military exercises that are fundamental to the US Pacific deterrent strategy. Maritime autonomy and undersea sensors work in Australia and hypersonics work in the UK that fit within AUKUS Pillar 2, and US Navy submarine trainer development efforts that fit within AUKUS Pillar 1. We've taken the further step of dedicating some 100 of our top engineers and solution architects to our frontline growth efforts. Operating in full partnership with our account managers and capture teams, they are positioned to bring the best of the best of Leidos to our customer needs. With the improvements we're making in the growth value stream, we are getting set up for a much better business capture performance in the future. At quarter's end, we had $26 billion worth of bids awaiting adjudication. And more importantly, quality is improving dramatically. Our pursuits are more aligned with our strategic direction, our proposals demonstrate greater customer understanding, and we are doing better at pulling through enterprise-wide technical expertise into each customer solution. So in summary, I'm very pleased with our financial results this quarter and the momentum that we're carrying into the back of the year. We're making great progress on our current four focus areas. This puts us in an excellent position to execute our emerging Leidos North Star strategy. I'm very proud of the 48,000 Leidos teammates who collectively every day ensure Leidos is making smart smarter for the benefit of our customers. And I'm honored that every day more and more of the best of the best wicked smart people in the nation join Leidos to break limits. I'll now turn the call over to Chris to walk you through our financial results in detail. He'll also provide insight into our upgraded outlook for the year and then we'll be pleased to take your questions. Chris? Chris Cage: Thanks, Tom, and thanks to everyone for joining us today. Our second quarter results demonstrate yet again the power of our focus on profitable growth and cash generation. With clear intent, our team is driving current financial performance while also building for a more prosperous future. Turning to the income statement on Slide 5. Revenues for the second quarter were $4.13 billion, up 7.7% year-over-year. Robust revenue growth reflects the benefits of both the strong demand environment and historically low levels of attrition. The highlight for the quarter was margin performance. Adjusted EBITDA was $559 million for the quarter, up 33% year-over-year, and adjusted EBITDA margin increased 260 basis points to 13.5%. We achieved this record margin through business mix and indirect cost management. Program-level execution was generally very strong, but EAC adjustments were a net $12 million headwind. Non-GAAP net income was $360 million and non-GAAP diluted EPS was $2.63, up 43% and 46%, respectively. Below-the-line items had no material impact on net income or EPS. Turning to the segment view on Slide 6. National Security and Digital revenues increased 1% year-over-year. We saw volume growth on our Sentinel and DES programs, as well as several contracted research and development efforts. You may also recall that last year we had spikes in some of our large digital modernization programs, notably NGEN and AEGIS, which created a tough year-over-year comparison. National Security and Digital is also the segment most impacted by protests. Still, accelerating growth in National Security and Digital is a major focus of the ongoing strategy discussion. National Security and Digital non-GAAP operating income margin increased 20 basis points from the prior-year quarter to 10.4%, with some milestone achievements, strong cost control and excellent program execution. For the first half of the year, National Security and Digital has been solidly ahead of plan on profitability. Health & Civil revenues increased 22% over the prior-year quarter, and non-GAAP operating income margin came in at 24.9%, up from 14% a year ago. The primary driver of revenue growth and increased profitability was higher volumes across our managed health services portfolio and an extra quarter of catch-up on incentive fee awards on our VBA disability exam contracts. Commercial & International revenues increased 3%, paced by an uptick in deliveries on security products, higher volumes in our commercial energy business and a hardware refresh in our Australian IT business. These drivers offset $39 million of write-downs in our UK business, primarily on two fixed-price mission software development programs caused by changing requirements and scheduled slippages. The UK write-down suppressed non-GAAP operating income margin to 0.7% in the quarter. Absent these write-downs, Commercial & International would have posted 9.7% year-over-year revenue growth and non-GAAP operating income margins of 8%. Although these write-downs are disappointing, they underscore the rationale for the new organizational structure. The C&I team is bringing greater focus on programmatic execution within the international portfolio and they quickly took action to ensure the long-term success of our UK operations. We're confident that we'll get back on track towards our financial and operational objectives within the UK. And on balance, we remain encouraged by the strong performance and demand signals across our Commercial & International segment. Finally, in Defense Systems, revenues increased 6% over the prior-year quarter on a total basis and 7% organically. And non-GAAP operating income margins increased 170 basis points year-over-year to 10.3%. Tom touched on the improvements the segment is making on program execution, and it is good to see the kind of financial performance that we expected from this portfolio. As we transition from development to production on some key programs, we see Defense Systems as a growth and margin driver for Leidos. We're making great strides towards unlocking the full potential of this business and are optimistic 2024 marks a significant turning point towards a brighter future. Turning now to cash flow and the balance sheet on Slide 7. We generated $374 million of cash flows from operating activities and $351 million of free cash flow. We had our highest collection week ever, which led to the exceptional Q2 performance. Overall, we're seeing a strong focus on cash throughout the organization. DSOs for the quarter was 58 days, an improvement of one day from a year ago and four days sequentially. In Q2, we repurchased a total of $114 million in shares, including $100 million on the open market, and paid $51 million in dividends. We ended the quarter with $823 million in cash and cash equivalents and $4.7 billion of debt. Our gross leverage ratio now sits at 2.4 times, which gives us plenty of financial flexibility. Next, I'll go through our enhanced outlook for 2024 on Slide 8. We're raising the lower end of our revenue guidance by $100 million, which gives a new range of $16.1 billion to $16.4 billion. We're increasing adjusted EBITDA guidance to approximately 12%. And we're raising our non-GAAP diluted EPS by $0.20 to a new range of $8.60 to $9. Our guidance for operating cash flow remains at approximately $1.3 billion for the year. This enhanced outlook reflects our strong first half performance as well as broad-based momentum across the entire portfolio, but let me walk you through some of the drivers of the second half performance for your modeling. Clearly, we're seeing strong momentum in our managed health services business. Last call, we signaled some potential second half revenue and margin headwind in our VBA disability exam business based on an upcoming recompete, which remains ahead of us. In addition, the unprecedented caseload of disability claims spurred by the PACT Act is straining the VA's budget resources. Earlier this month, the VA urged Congress to approve $15 billion to fund budget gaps in government fiscal years '24 and 2025 for risk cuts to veterans' benefits and care. The VBA customer has implemented several measures to proactively manage through these budget challenges, including dialing back its internal staffing, which suppresses industry case volume. We're already seeing the impact of this change with reductions in our near-term case backlog. Given that veterans benefits work is funded through mandatory, not discretionary budgets, and caring for veterans has broad bipartisan support, we expect underlying caseload to rebound in our fourth quarter. Notwithstanding this temporary funding issue, we stand ready to continue to deliver exceptional service to the nation's service members as a trusted mission partner to the VA. We expect Commercial & International margins to snap back in the second half, and for National Security and Digital margins to moderate somewhat, consistent with our commentary on the last two calls. And lastly, in the back half of the year, we've stood up a robust innovation fund focused on growth. Our bottom-line performance puts us in a favorable position to accelerate investments across the business, as seed corn for our emerging strategy to continue to drive sustainable profitable growth. With that, operator, we're ready to take some questions. Operator: Thank you. Ladies and gentlemen, we will now begin the question-and-answer session. [Operator Instructions] And our first question coming from the line of Mariana Perez Mora from Bank of America (NYSE:BAC). Your line is open. Mariana Perez Mora: So, my first question is on managed healthcare and the margins there and incremental margins there are really, really strong. How should we think about -- what is the moat that you guys have as you go ahead to this, like, competition and recompete coming? Because I could imagine like the installed base you have that actually allows for these incremental margins actually pose a really strong moat, but what else from a technical perspective you think that you have in your advantage to keep a good share of, like, this really growing market? Tom Bell: Thanks, Mariana. Really appreciate your question, and obviously, a part of the portfolio we're very, very proud of. The performance we're achieving in this part of the business is directly related to our passion to serve the nation and its veterans and our investment in technologies ahead of curve, so that we were poised to take additional volume as we came out of COVID and had an opportunity to serve more and more veterans. We're very proud of this and we're very proud of those investments that allow us to serve more veterans. And our modeling for what the output and input of veterans that need case management increases and stays the same over the coming years. So, we're very bullish on the absolute volume. What we're doing to affect our future in that overall volume is ensuring that VA sees us as their partners. So, we've leaned in to help make sure that they understand we are invested in their success and their budgetary challenges that they have right now. And that positions us well for this recompete that's coming in the third or fourth quarter, probably more like the fourth quarter. We expect the customer to expect us to continue to serve the veterans the way we are and we're very bullish about the opportunity for us to continue to invest in technologies that serve our customers even better. So, the challenge that we've given Liz and her team is not how to hold on to this business, but how to increase this business over time. So, as part of our year of deep strategic thinking, we're not seeing 2024 as the peak of this business. We're seeing it as a plateau of this business from which we continue to springboard. That's the challenge we've given Liz, and her and her team are responding very favorable to that. Chris, do you want to add anything? Chris Cage: Yeah, Mariana, I would -- Tom touched on the technology aspects, and clearly, that's been a major focus that we've added to the equation under Liz and Larry Schaefer's leadership over the past several years. But beyond that, we've been a longstanding partner here. We've won this recompete multiple times over. There's investments that we've made in physical locations, mobile locations, provider networks, critical staff, all of those things come to bear. And then, of course, the customer is going to evaluate what has your performance been. And, clearly, we can demonstrate a track record of strong performance with great customer satisfaction, great accuracy, throughput, all of the key metrics the VA is looking for. So, we're sharpening our pencils to make sure that we're putting ourselves in the best position possible to defend this critical work for ourselves, but obviously, it's an area we feel very encouraged about our position on. Mariana Perez Mora: Thank you. And if I may, my next question is about the -- as you focus on the account managers and capture these teams, what are the challenges you have on hiring and training the talent, both internal and people that you hire? Tom Bell: There's really a war for talent of these type of people, but we are bound and determined, as I've mentioned on previous calls, to make sure Leidos is the destination of choice for the best and brightest talent that's out there in the ecosystem. And so, what we've started to see, I mentioned, we've hired dozens of these account managers and we've allocated hundreds of people to be our solution architects for our new solutions. We have an environment in Leidos that is compelling. We are an employer of choice. And the more we win, the more people will want to be on the winning team. So, it's not so much a question of challenges. It's a question of helping them understand the opportunity that's in front of them for joining Leidos and the investment we're going to make in them to make a difference. People that are in this line of business are in this line of business because they want to serve their customers. And the most disenfranchising thing you can do for a customer -- for a person who is passionate about serving customers is not fully support them. So, Leidos is creating an investment strategy and we're investing in the people, processes and tools that allow them to affect their customers positively and bring solutions to them differentially. And that is the most compelling thing about coming to work for Leidos that we're hearing from others and attracting great talent as a result. Chris Cage: The only thing I'd add, Mariana, to that is, of course, a very good question, and Tom is right, I mean screening the right people to have the passion to want to serve the right customers' missions is critical. The area that we need to help them the most as they get into Leidos, there's clearly a tremendous amount of capability that we have that can be brought to bear to support those customers in multiple ways. Helping them understand the breadth of our offerings is an area that we are continuing to invest in and that's the reason why partnering them up with so many solutions, architects and other people that have been down that road is critical, but there's technology that's behind that as well. So, Gerry Fasano leads our growth office. He's very focused on that rollout plan and we're excited about that taking a lot of momentum here in the second half of the year. Matt Akers: Tom, I wanted to follow up. You talked about kind of some of the portfolio pruning initiatives you're kind of looking at. Kind of could you give us an update on where we stand there and kind of what inning we are at that whole process? Tom Bell: Yeah, sure. Thanks, Matt. As I said in my prepared remarks, we're done with the Leidos proprietary hypothesis of the future. This is our own exclusive proprietary view of what the world looks like in 2033 and therefore, what are the challenges our customers are facing in 2028 in order to affect that future. We're halfway through building our business strategy as a result and affected by that view of 2028. So, it's very much a today forward view and a future back view meeting in 2028. As we are starting that, Chris trailed in his comments that we've put a small investment fund out there, because ideas are starting to emerge from this year of deep strategic thinking that we know are winners. These are areas that we are going to be investing in, in the future. And although we're not going to articulate it, we're putting seed corn out there now in those areas, so that we're not waiting for the whole process to be done to do the obvious compelling things we want to do to affect our future here. So, we're very excited about that. Now, the overall objective and the parameters of our year of deep strategic thinking, I think I mentioned it in our last call, it's not going to be a pivot for Leidos, a 90-degree pivot or 180-degree pivot, it's going to be variations on the cores that we're in now. And so, we're going to be doubling down on our core strengths. We're going to be really focused on repeatable business models. We're going to really focus on speed. We know that our customers are very concerned with speed, but they're concerned also that the people they hitch their wagons to have to have the scale to solve complex problems differentially. So, speed and scale. Trusted Mission AI, there's a reason we had a whole day focused on Trusted Mission AI, because we think it is a compelling technological unlock for the futures our customers are facing across all the markets that we serve. And we're going to continue to look for those areas of white space that are adjacent to the current businesses we're in for investment. Now, obviously, Matt, in the spirit of your question, there's also going to be parts of the portfolio we are not going to differentially invest. I've mentioned this in calls last year. I do not believe in spreading peanut butter around and watching every flower bloom. I think all about differential investment for differentiated results, but there is also not any part of the business yet that is raising its head in the strategy process is saying it's obvious this does not belong in Leidos. So, don't think of this as portfolio pruning. Think of this as simply investing to maintain, investing to grow and investing to grow exponentially. That's the way we're thinking about our strategy process. All that will be discussed at full in our March Investors Day that we look forward to welcoming you to. Matt Akers: Great. That's helpful color. Thank you. And I guess if I could do one more, just latest thoughts on upcoming recompetes and anything big that we should be watching for this year? Chris Cage: Yeah, Matt, obviously, we talked a little bit, of course, about the VBA exam business and that's top of mind as we navigate to the end of Q3 into Q4. Beyond that, I mean, there's not as many needle movers. There is an exciting opportunity in the hypersonics arena where Common-Hypersonic Glide Body and TPS contracts converge and we look forward to extending our work there with an important customer. There is an integrated logistics support contract with the TSA that -- whether it's late this year or first quarter next year and obviously, you can imagine that's a partnership between our C&I business and work we do elsewhere that specializes in the logistics side. And then, looking ahead to next year, I think the other big one I'd point out is the DHMSM contract. The follow-on to that obviously is an important piece of work for us. The team is already in the proposal bids, making sure that we're putting our best foot forward, but that is sometime in the middle of 2025 -- early-to-mid '25. Tom Bell: Hey, just to pile on a bit, Matt, sorry to have a reclama here, color for our pipeline, we've got $15 billion in submits in the second quarter. We've got $26 billion-plus awaiting customer decisions. In the next 12 months, we have a pipeline of almost $70 billion, and our whole qualified pipeline approaches $200 billion. So, we're very excited about the opportunities to grow, and that's why we are very much focused on priming the pump of our business capture teams with talent who can differentially go out there and get this business. David Strauss: A question, Tom, on National Security and Digital. I think you guys hit on the slow growth there in the first half, but it sounds like you're talking about an acceleration in the second half, but at the same time it sounds like you're signaling lower margins in the second half. So, could you just dig in exactly kind of what's going on there in the second half versus the first half? Thanks. Tom Bell: Yeah, our National Security and Digital segment is arguably the core of the core of Leidos. And it is an area that we've put two of our most talented leaders, Roy Stevens and Steve Hull. And they are partnered to make sure that we are focused on how we help our customer in deterrence and being the smartest government on the planet. We don't think that there is a challenge here with the pipeline. Obviously, this is a business where we've won in the past. We know we can win in the future. The margins in this type of business are never going to be over the top. They're going to be in the low double-digits. But what we have in this segment, in my mind, David, is a revenue growth story. There is much more we can do to help our customers in these areas and our customers -- this comes back to the speed and scale conversation I had before, our customers are increasingly aware of the fact that the scale of the problems that they have requires people who have speed and scale to solve them. So, Roy and Steve are partnered with the whole enterprise with Jim Carlini in Technology and Gerry Fasano in Growth to make sure that we're leaning into serving our nation in this area and not looking to back off in any way. So, if we gave you an indication of softening here, that's probably not the guidance we'd want to give. Chris Cage: Yeah, David, I'd just add on to that. I mean, I think part of that is because we had an excellent first half of the year on margins. And there are some things that can move around, around milestone timing and things of that nature and how much special project work we see on programs like NGEN, but there's no fundamental issues here. And, in fact, we're actually very encouraged, to Tom's point, this will never be our highest-margin business, but we do see upside here over time and the teams are investing in more repeatable models in the dig-mod space and those will be some unlocks to future margin upside that we're expecting. But I don't want to overlook some important wins that did take place in the quarter. Getting the next Defense Enclave Services task order under contract is critical for us. That is a key unlock for Steve and his team to drive growth into that important program. So that clears the way for 13 additional DoD Fourth Estate agencies to migrate on to the network over time. So, we've been waiting for that and we're excited about what comes behind that as we get into '25 and beyond. David Strauss: Great. Thanks for that color. Chris, quick follow-up. You noted a pretty good working capital performance in the first half of the year relative to the prior year. How are you thinking about working capital through the rest of the year? Chris Cage: Yeah. So, I'm very pleased with the team's performance on cash management. I think we've done an excellent job. And last year, we made some really strong gains on managing the payable side and more industry standard terms with our vendors, and we've made some more progress in that regard this year. We've been attacking the DSO side. I would say, it's steady as she goes. I don't see anything at this point in time that would be a major use of working capital. We're always interested in great ideas that could be accretive to the business. But right now, we're focused on Q3 and Q4 are usually our strongest performance quarters and I expect this year to follow suit. David Strauss: Thanks very much. Operator: Thank you. And our next question coming from the line of Cai von Rumohr with TD Cowen. Your line is open. Cai von Rumohr: So, you guys have mentioned that you expect Health -- the medical exam business is not at a peak, it's at a plateau, but given [indiscernible] at least early on next year, we'll be under the new contract. Should we assume that the margins are going to be lower? Because I assume it takes time until you get to the point where you kind of are doing well in terms of the incentives and all of that. So, is it likely that profits in Health will be down next year? Tom Bell: I hate to answer your question this way, but we don't know is the real answer, because we're awaiting the RFP that tells us what the customer actually wants to do. We know that the contract comes to an end at the end of this quarter. We are awaiting the RFP for the future. We're not sure if that's going to be -- if we're going to have an extension to the current contract, a new contract for a fixed period of time or a new contract for a long period of time. And we don't know how the VBA is going to incentivize industry to bring its best and its most throughput to our veterans. So, we have no reason to model, in our own minds, a decrease in profitability, but there is a big unknown while we await the RFP. Chris Cage: Yeah, Cai, I'd only add, I mean, what we do know is that the VBA has asked Congress for more money, right? And that's a strong signal that they see the demand out there, more veterans need care, need throughput, and that's always been the priority. Now, we're in, call it, a temporary situation where they have to navigate this funding gap. Tom is right, I mean, a lot of things will become clearer for us as we get through the next quarter or two, but you can imagine that our early conversations with Health team about '25 is how do we grow off of '24 levels. And that's the way we're approaching it. And so, everybody's clear-eyed around looking at every opportunity to make sure we optimize our performance levels there and elsewhere to continue to grow earnings. Cai von Rumohr: Perfect. One quick one on your new business. You had $15 billion of submits, you have $26 billion awaiting. What should we think about in terms of your book-to-bill? You also have $3 billion in protest. I think there's a big classified award in there. Should we see book-to-bill pick up in the second half? And are you guys chasing some of the large takeaways you've been so successful in? Tom Bell: The team remains committed to a book-to-bill ratio slightly better than 1 for the year of 2024 and they are determined to meet or exceed that. There are some big swingers in there and it's possible that if many of these break our way, we'll far exceed the book-to-bill ratio that they have. But Cai, again, in my earliest call I talked about the fool's mission that chasing quarterly book-to-bills was in my mind, and the fact that what we should be focused on is building a quality backlog over time of profitable business. And that's really what I'm more incentivized and really focused on with the business capture team; how do we look at that trailing 12 months of book-to-bill and how is that looking at our future growth potential with the backlog that we've got on the books? The team is very focused on that. As I mentioned in my prepared remarks, we're doing a better job of bidding for the things that will reward Leidos adequately for technology and the capability we bring, and I feel as if many of those that are in our backlog will start to break our way. So, we're very bullish on the future without getting ahead of our skis. Cai von Rumohr: Terrific. Thank you so much. Operator: Thank you. And our next question coming from the line of Peter Arment with Baird. Your line is open. Peter Arment: Terrific results. Hey, Tom, maybe just the focus on Commercial & International, just you had the write-down in the quarter. Absent the write-down, you would have had pretty good margin performance. Maybe just talk a little bit about, I guess, either the write-down or just confidence level in kind of the back half of the year, where your margins are, I guess, expected to be better? Thanks. Tom Bell: Yeah, sure. Thanks. Well, first of all, this is very much the benefit of having new eyes and a new organization structure that's looking with fresh perspectives on the business. As Chris mentioned, this is primarily two fixed price contracts that we have in the UK that through increased and very robust conversations with the customers, we've decided we have to take a write-down because of changing requirements and schedule slippage. But we feel confident that we've also taken a lap around the block and looked under the rocks to make sure that there's not more. So, Vicki and her team are doing a great job scrubbing the portfolio. She's cut the number of watch programs in her portfolio by half in these first two quarters. And we feel very bullish about the prospects for her business. I mentioned and I featured in our last call last quarter that we want to make Leidos synonymous with AUKUS Pillar 2. And as you heard in this call, we've taken some steps by really allocating and hiring some talent that can really get after making that so. So, Vicki and her team are very focused on bringing the team together around AUKUS. We've got excellent customer touchpoints in the UK and Australia, and obviously, here in the United States, and we're very bullish on the opportunities for Commercial & International. Also, I want to tip a hat to the SES team. They had a very good first half of the year and that is all credit to Mike Van Gelder and to Vicki, who have really gotten their arms around that business and really made sure that we're on a solid platform from which to grow. So, very optimistic about where that business is heading in her portfolio also. Chris Cage: The only thing I'd add there, Peter, is the piece of the business there that Tom didn't mention is our commercial energy business and that has been performing extremely well and tends to have a pattern where the back half of the year is stronger on a margin basis. There are some critical incentive and award fee determinations that happen sometime later in the year. So, a well-run business that we expect to continue to deliver great results, and the other piece of the portfolio we believe are on strong footing for the second half. Peter Arment: Yeah, that's very helpful commentary. And then just Tom, just quickly the DoD continues to make a lot of evolving changes or strategies around Counter-UAS and I know that Leidos through Dynetics has some exposure here. How are you guys thinking about the portfolio when you're thinking about the Counter-UAS business today? Tom Bell: It's a very timely question, Peter. I have a classified briefing later this week to dive deep into all our capabilities for Counter-UAS. Obviously, IFPC and Enduring Shield is the thing we talk most about, about Dynetics. But within our Leidos Innovation Center, the LInC, and our Defense Systems segment, we've got a myriad of other technologies that can affect Counter-UAS capabilities for our customers. So, we're going to take a step back, kind of look at everything that we've got in the pantry when it comes to technology and decide, are there some things we should be investing in this year to help our customers with this very, very vexing problem that they're uncovering now. So, very bullish about our opportunity to serve. The question is, do we have something in the pantry that will be compelling for the customer. Operator: Thank you. Our next question coming from the line of Jason Gursky with Citi. Your line is open. Jeremy Jason: I kind of have a math question. Could you walk us through the pipeline for each of the segments for '25 and '26? And kind of give us an update on production capacity and how that might impact growth outlook? Thanks. Chris Cage: Well, Jeremy, Tom gave you some high-level metrics. We're probably not going to be able to dissect the pipeline by segment by year for you, but rest assured that we feel it is robust and each of the segments has opportunities north of $1 billion all the way down to some strategic small opportunities in the tens of millions of dollars. So, we like our positioning there. The big ticket numbers again, $26 billion pending, 200 overall pipeline, approximately $70 billion we expect to be decided in '25, two-thirds of that being new work and takeaway, great position on our BD side and the growth teams are highly energized. As it relates to production capacity, the good news is the Dynetics team had built up some capabilities down in Huntsville. We feel like we've augmented that in areas like the wide-field-of-view satellite payload needs. We've got a facility that we've been waiting to fill up from a capacity standpoint on the IFPC side, the Enduring Shield. So, we're excited about the ability to take full advantage of what we've got in place there. And then, we spoke previously on the SES side about our new Charleston facility that we toured just in the last few months. It's a great facility that the team has built out and in fact there's plenty of room to expand capability even in the footprint that we built out. So, I don't see a big need on major investments in those areas. It's always something that we look at and we're happy to entertain great ideas if there's a compelling expansion to the pipeline, but we're in good shape to be able to expand up to the needs that we foresee over the next 18 months or so. Tom Bell: And just to pile on a little bit on that, Jeremy, the $26 billion of pending awards we have, I mean, that is not only several home runs that we've got on deck, but 40, 50 big awards of $50 billion -- $50 million or more. So, we've got lots of proposals in work. And so, the batting average should be relatively positive on that. We've used the example internally of -- we've had a business capture problem and so to break that inertia, we have inputted energy, energy with new talent, energy with new processes and tools. And now we're very excited about the momentum that's going to build over the next 12 months to 15 months. You'll appreciate that in our customers' environment decisions take time and ultimately they're almost all protested. And so, it takes a little while before the flash of energy to break inertia becomes the bang of the momentum of actual wins, but we're highly confident that we're in a good place and Gerry is the right leader to bring us forward. Operator: Thank you. And our next question coming from the line of Ken Herbert with RBC. Your line is open. Ken Herbert: Hey. I just wanted to first start off, you obviously raised the guidance with the exception of the cash from operations. Is there anything in particular when you think about the cash flow outlook in the second half of the year we should keep in mind or maybe driving a little bit more conservatism there? Chris Cage: Yeah. Hey, Ken. Chris here. Obviously, we stepped up our cash guide last quarter by $200 million, a pretty significant increase. We're clearly focused on converting these extra earnings that you're going to see here into cash and there's always the chance that some of that comes in January versus December. So, at this point in time, with two quarters to go and two-thirds of our cash commitment for the year ahead of us, we just didn't feel it was prudent to increase the guidance at this time. But there's no headwinds that we're foreseeing, we're just kind of managing it down the middle. Tom Bell: And just to build on that, right, at the beginning of the year, we talked about the uncertainty in the market heading into an election year. Obviously, we're still dealing with some uncertainty. We're still dealing with customers that have budget challenges and issues around their performance of their business. And so, while we're extremely pleased with the first half of the year that allows us to raise our guidance again, we're not going to get ahead of our skis or over promise. We're going to keep our powder dry to make sure that the third and fourth quarter deliver the way we expect them to. Ken Herbert: That's great. Thanks, Tom. And if I could, it sounded like from your prepared remarks that there could be upside as well to the expected buyback this year, the $500 million. I guess maybe part of that's timing, but can you just reset in terms of what you might want to see to deploy more capital there? And maybe any change in how you think about the framework around returning capital to shareholders considering some of the investments you're talking about here today? But great, great cash in the quarter, really nice. Tom Bell: Yeah, sure. And great cash in the quarter is the reason that I only trailed it and didn't commit to more. We had great -- you know how the flow of the business comes. It's a little bit like a sine wave when it comes to cash coming in. And typically, the third quarter is a relatively robust cash quarter for our business. We had a very robust second quarter. So, I recommitted. We're committed to repurchasing $500 million worth of shares this year. We're halfway through that now. We'll continue that program. If the cash comes in per historical norms in the third quarter that may give us a chance to revisit it. But more on that as the third quarter unfolds and we look toward the fourth quarter. The one thing I will say Ken, just because to state the obvious, but not to assume it is stated, fear not, we're going to be -- continue to be prudent allocators of cash in a shareholder-friendly manner. And so, don't worry about this burning a hole in my pocket as my grandmother used to say. Operator: Thank you. And our next question coming from the line of Noah Poponak with Goldman Sachs (NYSE:GS). Your line is open. Noah Poponak: So, I guess the EBITDA margin has to be a lot lower in the second half than the first half to be at the 12% for the year, and the second half EPS as a percentage of the total would need to be a lot lower than it's been historically to be in the earnings range for the year. Obviously, the Health & Civil margin pretty strong in the second quarter, but you're also absorbing this C&I margin. So, can you maybe, Chris, just walk me through that? I mean, what -- which segment's revenue growth or margins really moderate a lot? How are you thinking about that Health margin through the back half of the year? Chris Cage: Sure. No, thanks, Noah. And we get it, right, excellent first half of the year, excellent full year guidance, but the second half relative to the first half looks a little bit more modest. But stepping back, the guidance implies, let's call it, roughly 11% margins in the second half of the year. And just six months ago, we opened the year with an expectation of 10.5% to high 10%s on margin. So, we're pleased to be able to look ahead and say, even in a scenario where the disability examination work levels perhaps come down, we still see line of sight to, let's say, 11% margins kind of being delivered by the business. And that's really the primary reason, right? As we look at as the VA is kind of navigating the next few months, we're expecting those throughput to be lower, and then we've allowed ourselves some cautiousness as we look into the fourth quarter around how quickly that will snap back. So, there are certainly scenarios where that could do much better, but that's the primary backdrop. As we look at the rest of the portfolio, obviously, we did signal that National Security and Digital has had a very strong first half on margins. There's always the potential those are able to sustain at those levels, but again, looking at some of the milestones, we pulled back a bit on that for the second half guidance. And then, the last piece, Noah, that I'd point to is the investments. Taking advantage of this opportunity to make sure we're funding an innovation fund that we can dial up or dial back depending upon the progress that's being made and really make sure that we've got a jump start on 2025. So, the fundamentals of the business across the board are in great shape. We feel good about that. In fact, there are some areas still on the optimization side that we still have ahead of us to get after on indirect cost management. So, I feel like we're really well positioned as we look ahead at '25. Tom Bell: Noah, I'll just foot stomp something Chris said in his prepared remarks, and that is our 2Q profitability was aided by having two quarters worth of incentives in - hit in the second quarter. So, the profitability of that business was enhanced because of that. The underlying business remains as solid as it ever has been. Noah Poponak: Okay. And Chris, the VBA, I guess, it sounded like you guys are saying you don't have an RFP yet. It sounds like recompetes imminently without an RFP yet. Chris Cage: Yeah. Noah Poponak: It's maybe unlikely, I don't know. Is that sliding out? Does that make an extension more likely? Chris Cage: That's how we see it. It's been fluid. We've been rehearsing and preparing and can adapt to any scenario, but it's becoming more and more likely that there is an extension of some kind versus recompete, but we can't commit to that. We're just prepared for whatever the VA is able to do in a short order here. Noah Poponak: But you still expect them to slow down the activity while that's being sorted out? Chris Cage: At least until -- they've got a new government fiscal year and that'll help them get into a new budget environment. Now, they -- again, they could be aided by Congress in the near term, but our baseline assumption at this point in time is activity levels are more muted over the next few months. Tom Bell: Olivia, it looks like we've gone beyond the hour. So, I think we'll call the Q&A at this point. So, I want to thank you for your assistance on the call and thank everybody on the call today for your interest in Leidos and we look forward to catching up with you in the future. Operator: Ladies and gentlemen, that does [conclude] (ph) our conference for today. Thank you for your participation. You may now disconnect.

Earnings call: Ecolab forecasts robust growth and margin expansion By Investing.com

Ecolab Inc . (NYSE:ECL), a global leader in water, hygiene, and infection prevention solutions, has reported strong financial results for the second quarter of 2024. The company announced a 35% increase in adjusted earnings for Q2 and raised its full-year earnings growth outlook to between 25% and 29%. Ecolab's operating income margin soared to a record 17% for the quarter, up by 360 basis points. The Institutional and Specialty segment was a standout performer, achieving an operating income margin of over 20%. Ecolab's CEO, Christophe Beck, discussed the company's strategic initiatives, including the One Ecolab plan, which is expected to bolster long-term growth and margin expansion. Key Takeaways Company Outlook Bearish Highlights Bullish Highlights Misses Q&A Highlights Ecolab's second-quarter performance reflects a robust growth trajectory and margin expansion, driven by strategic initiatives and market share gains. The company's focus on technology and innovation, coupled with its One Ecolab plan, positions it well for continued success in the global market. With a rich M&A pipeline and a commitment to operational efficiency, Ecolab is poised to deliver on its ambitious growth and profitability targets. InvestingPro Insights Ecolab Inc. (ECL) has demonstrated a remarkable track record of financial resilience and shareholder returns. An important highlight for investors is Ecolab's commitment to consistent dividend payments, having raised its dividend for 38 consecutive years, which speaks to a reliable income stream for shareholders. This is underscored by the company's ability to maintain dividend payments for over half a century, a testament to its financial stability and prudent capital management. From a valuation perspective, Ecolab is currently trading at a high earnings multiple, with a P/E ratio of 41.94, which is above the industry average. This indicates that investors are willing to pay a premium for the company's shares, possibly due to its strong market position and growth prospects. Additionally, the company's Price / Book ratio stands at 7.96 as of the last twelve months ending Q1 2024, reflecting a valuation that factors in Ecolab's robust asset base and potential for future earnings. Investors should also note that Ecolab has been profitable over the last twelve months, with a reported revenue growth of 6.95% during this period, signaling the company's ability to expand its top-line in a challenging economic environment. These financial metrics are crucial for investors looking to gauge Ecolab's market performance and future potential. For those seeking deeper insights and additional metrics, InvestingPro offers valuable analysis and data to help make informed investment decisions. By using the coupon code PRONEWS24, readers can get up to 10% off a yearly Pro and a yearly or biyearly Pro+ subscription, unlocking access to a wealth of InvestingPro Tips. Currently, there are 9 additional tips listed on InvestingPro for Ecolab, which can provide further guidance on the company's financial health and investment potential. Full transcript - Ecolab Inc (ECL) Q2 2024: Operator: Greetings. Welcome to the Ecolab Second Quarter 2024 Earnings Release Conference Call. At this time all participants are in listen-only mode. A question-and-answer session will follow the formal presentation. [Operator Instructions] As a reminder, this conference is being recorded. At this time, it is now my pleasure to introduce your host, Andy Hedberg, Vice President Investor Relations. Thank you Mr., Hedberg, you may now begin. Andy Hedberg: Thank you, and hello, everyone, and welcome to Ecolab's second quarter conference call. With me today are Christophe Beck, Ecolab's Chairman and CEO, and Scott Kirkland, our CFO. A discussion of our results along with our earnings release and the slides referencing the quarter results are available on Ecolab's website at ecolab.com/investor. Please take a moment to read the cautionary statements in these materials, which state that this teleconference and the associated supplemental materials include estimates of future performance. These are forward-looking statements and actual results could differ materially from those projected. Factors that could cause actual results to differ are described under the Risk Factors section in our most recent Form 10-K and in our posted materials. We also refer you to the supplemental diluted earnings per share information in release. With that, I'd like to turn the call over to Christophe Beck for his comments. Christophe Beck: Thank you, Andy, and welcome to everyone on the call. I'm happy to share my perspective before we jump into Q&A. But in summary, with 35% adjusted earnings growth in Q2 and 25% to 29% earnings growth expected for the full year, I feel very good about where we are and even more where we going. Ecolab's very strong business momentum continued in the second quarter. Our team delivered for our customers and delivered for our shareholders. Organic sales growth remained in its previously forecast 4% to 5% range, as growth in our institutions and specialty segment, normalized to a strong 7%, lapping last year's very strong 13%. Performance across the rest of our segments further improved. Our growth continues to be leveraged by exceptional organic operating income margin expansion. Margin increased by 360 basis points to 17%, which is a record second quarter margin for Ecolab, resulting in the very strong 35% growth in adjusted earnings per share. With continued top line momentum and operating margins expanding towards our 20% target. We remain firmly on our long-term 12 to 15 earnings growth trajectory. Looking at our segments, Institutional and Specialty continued to perform exceptionally well, delivering strong organic sales growth on top of last year's double-digit gains. Importantly, our business continues to significantly outperform softer restaurant food traffic trends, as our customers look to Ecolab's labor savings technologies to improve their operational performance. This growth was leveraged by continued robust operating income margin expansion with Institutional Specialties margin already exceeding 20%. Growth in our Industrial segment improved, despite continued volatile end market demand. Water sales growth accelerated to 4%, led by strong growth in downstream and double-digit growth in our global high tech business, which serves the rapidly expanding data center and microelectronic industries. As expected, sales in food and beverage were stable as good new business wins offset comparisons to last year's double-digit growth. Performance in paper improved also, a trend we can - we expect to continue, as new business wins helped us accelerate those end markets stabilized. Our Healthcare & Life Sciences segment also showed better performance. Life Sciences growth improved to 4%, as attractive share gains allowed us to outperform ongoing short-term soft industry trends. We continue to expect modest growth in our Life Sciences business during the second half of the year. Healthcare sales were down modestly, as we continue to exceed low margin business to improve our profitability. Our healthcare transformation is progressing very well. At a previously announced sale of our Global Surgical Solutions business to Medline is moving exactly as expected, subject to customary regulatory and closing conditions, we expect to close this transaction and very soon. As discussed when we announced the sale last quarter, once closed, the transaction will reduce our Healthcare & Life Sciences quarterly sales by about $100 million in quarterly operating income by about $15 million. Longer term, healthcare continues to sharpen its focus on and it's very healthy anchor instrument reprocessing business that combines consumables, personal service and digital solutions, while in other words, but typically Ecolab business, whether it is much more to be done, I'm proud of the progress we've made to create a sustainable, profitable healthcare business that will deliver even stronger value of our important hospital customers. Pest Elimination once again continued to execute exceptionally well. Organic sales grew 9% and organic operating income grew double digit, benefiting from our enterprise cross-selling strategy and innovative digital capabilities. As we continue our long-term growth journey, I'm excited to share details of our One Ecolab initiative, which will help fuel 5% to 7% long-term organic sales growth and continued to expand our operating margins towards 20% and beyond. We know what best-in-class performance looks like, the best restaurants, the best hotels for the best data centers. And we know how to deliver this by our customers, because of our experience serving millions of locations in more than 170 countries, across 40 industries. By leveraging more than 100,000 system connections and billions of proprietary data points on business outcomes, operational performance, and environmental impact, we can demonstrate how an entire network of customer sites can operate a best-in-class performance to deliver even more customer value. This will help us drive attractive growth by continuing to capture more share of our existing $55 billion cross-sell opportunity. At the same time, these new technologies will allow us to enhance the way we operate and serve our customers by realigning the function and worked on across hundreds of offices around the world into major global centers of excellence. The resulting total annualized savings of approximately $140 million are expected to be realized by 2027. Put simply One Ecolab will enable customers to reach best-in-class performance on all three fronts, business outcomes, operational performance and environmental impact by leveraging Ecolab's complete offering. Looking to the balance of 2024, the confidence we have in our performance continues to strengthen. As a result, we're increasing our outlook for full year 2024 adjusted EPS to the range of $6.50 to $6.70, up 25% to 29% versus last year. As previously discussed, this range includes an unfavorable impact in the second half of 2024 from sale of our global Surgical Solutions business. The unfavorable impact to 2024 adjusted EPS is now estimated to be $0.08 a share, which is a bit more than we had previously anticipated as we expect this transaction to close very soon. This is very good news, but it also has a bigger impact on the full year. FX on the other hand has also become more of a headwind and is now anticipated to be about $0.09 drag to full year EPS, and despite its incremental headwind to EPS, we still have increased our guidance range, which demonstrates the strong underlying momentum we have in the business. We expect to keep growing our organic sales at a similar rate as in the first half of the year, driving 2% to 3% value pricing and 1% to 2% volume growth. Attractive operating income margin expansion is expected to continue to second half 2024. The rate of exceptional expansion will moderate as benefits from lowered delivered product cost we continue to ease. Finally, we continue to anticipate quarterly adjusted diluted earnings per share growth to progressively normalize towards Ecolab's long-term 12% to 15% target as solid growth continues and impact from delivered product costs expected to normalize exiting 2024. As always, will remain good stewards of capital by continuing to invest in the business, increasing our dividend and returning cash to shareholders with great business momentum and cash flows. Our balance sheet is in a very strong position. This provides us with many options to allocate capital to growth opportunities that will generate continued strong returns for shareholders. Ecolab future has never looked brighter. Our leading customer value proposition where our technologies help customers improve the operating performance while reducing their water and energy use is increasingly relevant and continues to fuel our growth, pricing and margin expansion. We therefore, remain confident in delivering superior performance for our customers and shareholders in 2024 and beyond. So thank you for your continued support and investment in Ecolab. I look forward to your questions. Andy? Andy Hedberg: Thanks, Christophe. That concludes our formal remarks. Operator, would you please begin the question-and answer-period? Operator: Yes. Thank you. We will now be conducting a question-and-answer session. [Operator Instructions] And our first question is from the line of Tim Mulrooney with William Blair. Please proceed with your questions. Tim Mulrooney: So I wanted to dig into the institutional segment a little bit here, which had really strong ally margins in the second quarter, but probably the strongest I've ever seen from the second quarter. I think margins typically taken the third quarter. But I'm wondering if that's the expectation this year given what we saw in 2Q? And were there any one-time factors that could help me here that we should be aware of for our models? And if I could sneak in a part to just to touch on the growth side that you're seeing in the institutional business right now, which looks really good. I was just curious how you're thinking about the sustainability of that strong performance in the second half of this year and into next year. Thank you. Christophe Beck: Thanks for the question. Tim, very pleased with the Institutional and Specialty segment. They're performing exceptionally well. As you've seen, as you know, so they're lapping against the 13% top line growth in Q2 of 2023. So the 7% for this year is really strong, especially in a market where food traffic is down 4%. So quite a remarkable performance. The margin that we had in Q2 were very clean for that segment. And as you know, it's a little bit seasonal, so by quarter, but generally, margins are going to remain north of 20%. And as we've said, for the full year, we should reach the 22% targeted OI margin for 2024 as segment keeps improving as well from there. So good top line, huge interest from customers, very clean. And from a margin perspective, so very strong, and it's going to keep improving as well in the next few quarters and years. So, very pleased with what IMS is doing. Innovation is also adding a lot as well as to the firepower of that business. As you know, our customers are trying to find solution to manage labor shortages, wage growth as well that they have. They need more automation, they need more systems, they need more digital technology. This is exactly what we're providing our customers. So, all-in-all, as I've shared with you many times before the pandemic, for me, institutional was kind of a steady good business for the future of Ecolab. Now, a few years later, I'm extremely bullish about that business because we're uniquely positioned to gain a lot of share at very high margin. Operator: Thank you. The next question is from the line of Ashish Sabadra with RBC Capital Markets. Please proceed with your question. Ashish Sabadra: Thanks taking my question. I just wanted to focus on the raw price dynamic. How should we think about the raw material tailwinds going into the back half of the year. And we've continued to see pretty robust gross margin expansion. How should we think about the SG&A operating leverage going forward? Thanks. Christophe Beck: Thank you, Ashish. I'll pass that question to Scott. Scott Kirkland: Yes, Ashish, thanks for the question. Just -- answering your first question, as we think about the DPC, as Christophe talked upfront, we saw the favorability in Q2, high single-digits. We're expecting that favorability to taper as we go into Q3, sort of, call it, low to mid-single-digits. And then by Q4, raws to get really stabilized as we think about them and going into next year, frankly, we're seeing a world where raws get back to sort of normal inflationary levels next year. Certainly, given the amount of raws, the thousands of raw materials that we buy, they move around differently in some cases, like caustic, you've seen favorability. But in other commodities, you're seeing them go the other direction, oil-based commodities in particular. And then as we think about the SG&A leverage, which your two-part question is -- as we talked about last quarter, we are making really smart growth-oriented investments, which is really driving the lion's share of the increase second quarter, the 6% year-over-year. And those investments are in frontline firepower, technology, digital technology, which is all helping long-term productivity. And we feel very good about that underlying productivity. So, in long-term, expect to get at least those historical levels of productivity going forward. Operator: Our next question is from the line of Manav Patnaik with Barclays (LON:BARC). Please proceed with your question. Ronan Kennedy: Hi, good afternoon. This is Ronan Kennedy on for Manav. Thank you for taking my question. With the One Ecolab initiative, I understand the long-term guidance framework unveiled at September 23 Investor Day. I understand that contemplated SG&A productivity in addition to GM recovery. But to what extent did you consider this One Ecolab initiative and related benefits? Was it fully considered or is it incremental? And what impact -- what's the impact on the targets, the trajectory, the timeline for realization, if any? Christophe Beck: Thank you, Ronnie. It's all going to support, obviously, our commitment to reach the 20% OI margin as quickly as we can. But most importantly, One Ecolab is a growth initiative. It's really helping fuel towards the 5% to 7%, which is the other commitment that we've made as well, which leads to this 12% to 15% earnings per share growth. When you think about it for One Ecolab, our company has anchored its strategy on circle the customer, circle the globe for a very long time. The opportunity is huge, $55 billion and close to $3 billion for our top 35 customers. Well, up to now, we had to rely very successfully so, by the way, on our teams to work together in order to provide whole value of Ecolab to our customers everywhere around the world by working together by reaching out by working as one team. One Ecolab is today hardwiring all that, that ultimately we can help our customers take a restaurant chain, for instance, understand what's my best-in-class performance that I should be aiming at, because we know what the best restaurant performance is out there. In terms of guest satisfaction, in terms of cost, in terms of environmental impact, and we can help them understand what's potential for the company, for the set of restaurants, and we will share that upside between us as value price and obviously, for the customer a net-net positive for the customer. Well, that helps us grow. That helps us improve our margin, that helps our customers improve their performance. So it's a win-win that drives as well retention or loyalty. So at the end of the day, it's growth focused and at the same time, the technology that we're using will help us reorganize the way we work, serving those customers as One Ecolab, that's going to improve as well as the productivity. We've had 20 to 30 basis points in the past of SG&A productivity growth, that's going to improve as we go forward as we implement One Ecolab, but at the same time, as Scott was mentioning before, today, we also reusing some of that margin upside in order to reinvest in growth investment. All-in-all, that will help us get to the 20% and go beyond by driving 5% to 7% top line growth. Operator: Our next question comes from the line of John Roberts of Mizuho Securities. Please proceed with your question. John Roberts: Yes. Maybe just further follow-up on that, Christophe. It sounds like you plan on creating centers of excellence. So what would the center excellences be? And is the charge for severance for some of the functions that are going to be replaced by the Center of Excellence? Christophe Beck: So, John, I'll let it to Scott to reply to that question. But generally, we've been so over the years, always evolving way we work, especially with all the technology capabilities that we have. So most of the investments share from all the technology to newer technology to that new way of working, which ultimately is going to help us grow faster and drive productivity, but bottom line, the good thing is that our team will keep strengthening as well in the meantime. So there will be no net negative for anyone in the organization. Is that Scott? Scott Kirkland: Yes. Thanks, John. I'll add to that, Christophe. As he said, this is not about the restructuring. It's not about cost savings. This is focused on growth. The savings, honestly, John, are pretty immaterial in context of the P&L. And if you think about this over a three-year program, the net sort of cost and savings are less than 1% on average over the next few years, really starting in 2025. But as we think about it, to your question on what that sort of nature it is and what's happening that is it's not about cutting the jobs, but about realigning where the work gets done, moving work to these centers of actions functional work really. To support the growth, create scalability to Christophe earlier point, that helps drive incremental productivity from a long-term perspective. And then to your question on the charges, the special charges will include severance. As we move work from many countries into these global COEs. But also there are other costs in there, including advisory costs, other costs, facility related costs. But again, these are going to happen over the next few years. Operator: Our next question comes from the line of Joshua Spector with UBS. Please proceed with your question. Lucas Beaumont: Yes. Hi. This is Lucas Beaumont on for Josh. So just looking at the second half assumptions, typically like Ecolab will get a step up in EPS of sort of $0.25 or more 2Q to 3Q, I mean, there's only been a couple of instances in the last 10 years where that didn't happen. So your guide is kind of assuming that it's only up going to $0.12 to $0.20 at the high end. So firstly, I was wondering if you could just kind of walk us through why that normal seasonality doesn't make sense this year. And then secondly, the typical like 4Q move is like flat to down modestly, which is basically what you've assumed in your guide. So if we had a more typical 3Q move and then we get the normal 4Q move, you'd be pointing more to like 680 for the year versus where you guys are at on the 660. So just trying to understand sort of what's different in the setup this year, please. Thanks. Christophe Beck: Thank you. I'll let Scott start and I'll build on that. Scott Kirkland: Yes. Feel free to add to this, Christophe. Obviously a lot of move around, as Christophe talked in the second half, don't forget that. Well, we will have the, the impact of surgical, which will be a headwind, which we talked about, about $0.08 in addition to the additional headwinds that we'll see from FX. But overall, as you see this, the sales we expect to continue to accelerate throughout the year, right. And you typically see sales being higher in sort of the second and third quarter of the year. And then on the other side of this, you'll see the year-over-year margin expansion start to we'll continue to expand. But it will ease through the third quarter, as DPC eases and then DPC becomes sort of stable and ultimately a headwind next year. And so I think you have some dynamics here that are probably not going to be able to compare the second half of this year to the normal years. But getting back to this is really the - if you look at our earnings growth that we're going to drive very strong earnings growth and even excluding the DPC tailwinds, we're getting at third quarter. And then the stable DPC in the fourth quarter that we're going to be driving underlying EPS at the high end of our long-term 12% to 15% range. Christophe Beck: Yes, I feel really good about the second half here, when you think about it, so 35% earnings growth in Q2, 14% to 20% expected in Q3, 12% to 18% for Q4 with the midpoint of 15%, as Scott said. So with no DPC help as well at that point, including as well the impact of the surgical sale and FX as well, while demonstrates the strong business momentum and margin upwards momentum that we have as well here. So very consistent, very steady, feel really good about where we're going here. Operator: Next question is from the line of Chris Parkinson with Wolfe Research. Please proceed with your question. Chris Parkinson: Great. Thank you so much. Chris, I'd like to dig in a little bit more on Institutional and Specialty, just given kind of all the macro dynamics and your relative outperformance. But can you break down, everything that's going on in quick service, including some of these perceived value ores and obviously the mechanics of food retail and then lodging in the institutional side of it, what's been driving the degree of material outperformance. And when we think about the second half into 2025, does your team see actually any further improvements there, or is it going to be primarily market share gains that's going to drive the narrative for the foreseeable future? Thank you. Christophe Beck: Yes. Thank you, Chris. It's mostly market share gain, as it's been as well. So the past few quarters as mentioned, so the food traffic in restaurants in the US is down 4%. So that's really showing how much we're gaining share. The main driver in institutional and specialty of our performance is that we are helping our customers with labor automation. They don't find labor and labor is expensive at the same time and with a high turnover. Other than that, so it's pretty easy for our customers. So, it's pretty hard, obviously. All solutions that we provide them, being chemical solutions are helping doing three-in-one or our new machine program like the AI Dish Machine that we introduced at the National Restaurant Association Show a few months ago or our digital technologies as well are all helping our restaurant and hotel customers to serve more guests in a better way while using less labor. Well, this is exactly what they need. This is exactly what we're providing them. And it's exactly what competition can't really provide. So, you put it all together, that drives growth at a higher margin because everybody wins. Operator: The next question is from the line of John McNulty with BMO Capital Markets. Please proceed with your question. John McNulty: Yes, good afternoon. Thanks for taking my questions. When you look at the industrial business, it looks like it's kind of a -- there's the haves and have nots and you're seeing some decent growth in areas like water, food and beverage paper still maybe struggling a little bit. I guess, can you give us your outlook for the industrial markets as you're looking forward into the back half of the year and early next year? What you're hearing from your customers, especially on some of the areas that may be struggling like the heavier water applications? Christophe Beck: Thank you, John. Generally, I like the progression that industrial is having. So, if you take a little bit the broader picture, the last figures, industrial has done unbelievable work in terms of margin improvement. We've reached a record level as well. And the shift to offense a year ago that we started is starting to bear fruits as well in terms of top line momentum, which is exactly where we wanted to be, getting top line moving while keep improving as well the margins, and that's exactly what's happening. So, we've moved overall segments from 1% growth in the first quarter to 2% in the second quarter. Within that as well, our largest business, which is water is at 4%, which, by the way, has been impacted as well by mining. So, underlying water would be even stronger in the downstream is really strong in water as well. Global high-tech is doing extremely well as well at the same time. So, industrial shifting very nicely. When I think about F&B and paper, they're going to keep improving in the quarters to come. So, bottom-line, you will see industrial shift even further up with very strong margin of 16% today, which is 200 basis points better than where we were in 2019. So, I think that we've really managed that very, very well and the best is yet to come. Operator: Our next question is from the line of Jeff Zekauskas with JPMorgan (NYSE:JPM). Please proceed with your question. Jeff Zekauskas: Thanks very much. In the first quarter, our year-over-year volume growth was 2%. In this quarter, your year-over-year volume growth is 1%. Is the reason for the deceleration, a deceleration in volume growth in the institutional business because of tougher comparisons? And secondly, do you have a target for your global industrial business. I know you want to get to a 20% margin, and that's the business that's maybe at, I don't know, 16.5%, something like that. Do you have a goal for that business? Christophe Beck: Thank you, Jeff. As mentioned just before, so industrial is at 16% right now, it's 200 basis points better than what it was 2019 and ultimately, we want to have industrial move towards the 20% as well, getting to 18% will be already a good step in that direction. And if we get industrial to 18% and all the other businesses get to the target, we will get north of 20% as a whole company. So feel really good about both getting beyond the 20% as a whole company and 18% for industrial, which is an unbelievable margin when you compare to competition. Now your first question on volumes, so from 2% to 1%, well, you comment was the answer. It's the lap between Q2 institutional this year versus last year, which was 13%. That's bringing the 2% to 1%. So it's a year-on-year comparison. Other than that, all businesses, all segments as you've seen, have been improving as well in the meantime. So year-on-year optical comparison, and all businesses are improving very nicely, which is why I feel good about the business momentum. Operator: Our next question is from the line of David Begleiter with Deutsche Bank (ETR:DBKGn). Please proceed with your question. David Begleiter: Thank you. Christophe, back on to the One Ecolab initiative. Do you need to make any additional investments to support this initiative? And how should we think about the rollout -- initial revenue drivers from this initiative? Christophe Beck: So David, thank you. It's going to be progressive. There is no revolution that's to be expected here. A lot of ground work has been done over the past few quarters as well as we now also get into execution mode. All the investments are planned in our numbers as we will share. So no surprise to be expected. So from that initiative, it's really an initiative that's helping us get towards this 5% to 7% as quickly we can. And I feel really good because we know that the €55 billion cross-sell opportunity that we have out there. And again, as mentioned before, out of the top 35 customers, we have $3 billion is available there. Well, this easier top line that we can get at a higher margin because obviously, we're serving those customers already. So the cost to serve is much lower. So when you bring it all together, it's very it's very organic, natural. There's no revolution. It's what customers have been asking for years as well. What our teams are expecting as well that when they go and serve a customer while they get the full picture of what we're doing for that customer today. At the same time, they understand what could be the best-in-class performance, how much additional value they could generate, what are the programs that they could sell to them as well and then developing an execution plan for the customer to get there and ultimately to get paid for it through the value pricing that we've been developing over the past few years. So bottom line, very organic, no incremental cost that we haven't included in our numbers as well in here. So I feel really good about where we're going with One Ecolab here. Operator: Our next question is from the line of Pavel Molchanov with Raymond James. Please proceed with your question. Pavel Molchanov: Thanks for taking the question. We haven't seen any M&A of late, even on a kind of bite-sized or tuck-in scale. I'm curious how you're currently evaluating the acquisition pipeline? Christophe Beck: Thank you, Pavel. So I can't go in too much detail for obvious reasons with M&A. We've done several smaller ones over the last few years following, obviously, the acquisition of Purolite at the end of 2021. We wanted to make sure we got that integration well done, that we got the right platform for the future that we could get as well our leverage ratio also back to two. That was our promise as well. We're getting there as well as we speak, even more, obviously, with the sale of our Surgical Solutions business. So it's all done in a thoughtful manner, both from an execution perspective and from a financial perspective as well. What I can say is that our M&A pipeline of big and small opportunities is very rich. We entertain all those connections on a regular basis as well. The fact that we have a great business, performing extremely well with one of the strongest balance sheet that we've ever had, puts us in a unique position obviously, so to go after opportunities that we believe. So it would be the right one for us. So what you've seen in the past is what you're going to see in the future, but always focused on our three key priorities, as I've shared many times with you. First, it's going to be water. Second, it's going to be digital. And third, it's going to be life science. So those are going to be the main areas where we're going to be investing in M&A as well. Operator: Thank you. Our next question is from the line of Laurence Alexander with Jefferies. Please proceed with your question. Unidentified Analyst: Hi. It's [indiscernible] for Lawrence. Just a little bit on the other side of the coin. You did a divestiture in the low-margin healthcare, and forgive me if you've said this in the past, but are there other businesses, which you can look at where you might be exiting as well within that segment or within others? Christophe Beck: Not really. We, obviously, look at our portfolio on a regular basis. And really, you think the way on who would be the best owner for that business. That's been true for a very, very long time. And the surgical business was an obvious candidate, because it is a product business, it's not service business where we can apply the Ecolab model, where you have service, technology, chemistry and data that come together. Surgical was purely drapes, great drapes, obviously, but those are products. That's a business that fits very well in a Medline portfolio, much less in our own company. So that's one of the reasons why we've sold this business. At the same time, we want to make sure that our healthcare business can build from a smaller scale, a much healthier business for the future and really focused on instrument processing, which is a typical Ecolab business. Beyond that, there's no obvious business out there that that doesn't fit the portfolio doesn't have the right performance. I like a lot the broad-based nature of the performance of the business across businesses and across markets. So, in short, no obvious candidate out there to do something similar. Operator: The next question is from the line of Shlomo Rosenbaum with Stifel. Please proceed with your question. Shlomo Rosenbaum: Hi, thank you. I just wanted to ask Scott to maybe dig a little bit deeper just on that volume question that was brought up before. I understand the mathematical implications of institutional growth slowing, but -- because of the comps, how should we think of that in the second half of the year? If you look at it, you -- on a total company volume, you grew 1% on a negative 1% last quarter. If you had 0% or flat volume in 3Q, does it make it tougher in order to generate the volume growth for the second half of the year? So, just trying to get to how we should think of the volume growth going forward? And then if you don't mind, I just want to ask a housekeeping question, we saw a spike up sequentially in interest expense about $7 million, but the debt level was relatively the same. I don't know if there were some inter-quarter borrowing or is there something else that's included in that line? If you could just clarify that, so we can straighten that out for our model? Scott Kirkland: Yes, I'll start with your last question first. If you just look at interest expense overall year-over-year, we had cash that we used to pay down debt earlier in the year in the first quarter. So, there's some impact from that as cash has come down from over $900 million at the end of 2023 to at the end of Q2, it's about $380 million. So, that's probably the biggest driver as we look sequentially on interest expense. Expect interest expense in the second half to be in that call it, $60 million to $70 million range, which is inclusive of benefit we'll get from the Orchid proceeds, which is, as you've seen in the disclosure, the gross proceeds there are about $950 million. So, back to your earlier volume question, when I think Christophe hit on exactly, which is an to Jeff's earlier comment, as we look at that sequentially, on the volume, it's really the impact of the comparisons to the institutional volume coming down from Q1 to Q2 on the more difficult comps and as we think about in the second half in that range that Christophe talked earlier in this 1% to 2%. Christophe Beck: And maybe building on that, my commitments to you has been so to get to this 5% to 7% as quickly as we can. 4% to 5% this year, as I've said, not every quarter is going to be created equal, mostly because of year-on-year comparison. So, 4% to 5% this year towards 5% to 7% doesn't seem to be like something crazy especially with the momentum that we're showing, and industrial also getting better, as mentioned, past remaining very strong. Institutional being in a very strong position as well. And when I see all the investments that we're making as well out of the margins improvements that we have with more feet on the street, with more capacities in growth businesses like global high tech, with more capabilities in digital and innovation around the world as well, I feel good with the trajectory that we're having moving from this 4% to 5% to 5% to 7% is going to happen so very naturally. Operator: Our next question is from the line of Steve Byrne with Bank of America (NYSE:BAC). Please proceed with your question. Steve Byrne: Yes. Thank you. I'd like to hear your view on two potentially meaningful longer-term opportunities in water. The first one being this initiative you talked about last year where you're going to be going after these -- I don't know, what is 150 companies that consume 20% of global freshwater, is that an initiative that still has a meaningful potential for you. And then the other one is with PFAS being classified as hazardous, that means every company that manages or uses it, will have to report it in 2025 under TRI, is that an initiative you are following? Christophe Beck: Thank you, Steve. So two parts, obviously, very different components of your question here. So first, in terms of focusing on the 150 companies that use a third of the world water. This is where we focus all our attention. And as mentioned before, so our laser focus on our top 35 customer as a company aligns perfectly well with that vision of the world of those 150 companies using a third of the world water. Those are the ones that are the more interested, obviously, in our technology, helping them produce more while reducing their cost, by reducing the usage of energy and water. This is working really well, which is one of the reasons where our water business is doing well and keeps accelerating as well at the same time. Now on the PFAS question, which is an old question, we have all the technologies to get that done the right way. Regulation is going to help in a certain extent where everyone will have to play with the same rules. So we are really focusing on our customers today, helping them get plans on how to address that PFAS issue that turns into a business opportunity. So for us over time. And we focus mostly on food and beverage customers, those are the ones who have the highest interest right now. And I like progress that we're making here, but it's going to take some time to see it happen or having an impact on our top line growth. But at some point, it will. Operator: Our next question is from the line of Kevin McCarthy with Vertical Research. Please proceed with your question. Kevin McCarthy: Yes. Thank you and good afternoon, Christophe. My question relates to the potential timing attached to your long-standing EBIT margin goal of 20%. Would you expect to achieve that margin target coincident with the $140 million of savings from One Ecolab or perhaps sooner than that or later. I appreciate that the macro environment obviously has something to say about the timing, but I would certainly welcome any updated thoughts on that glide path and time frame. Christophe Beck: Thank you, Kevin. It was in September or October last year that I said we will get there, so within a few years. And for sure, less than five. Well, we're almost a year later. So it's kind of the same and a year closure. To that, if anything, I feel more confident that we're going to get there. We're going to get there in time. There is no direct correlation between the One Ecolab savings and that margin, as Scott was saying before, we're talking about smaller numbers. This $140 million in the grand scheme of things. One Ecolab is mostly a growth initiative which will help, obviously, on the SG&A, but most importantly, will drive the margin, gross margin even higher, which will lead us to an OI improvement. So I stick to where we were within the next few years, and we see the PCs coming very well together. Gross margin is already close to 44%, which was the high watermark. For our company, we keep improving from there. Our SG&A is 200 basis points below where it was pre-pandemic as well in 2019 and will keep accelerating as well. Well, you bring all three together nice top line acceleration, gross margin further improvements and productivity improvements as well will mathematically lead to the 20% fairly soon. Operator: Our next question is from the line of Patrick Cunningham with Citi. Please proceed with your question. Patrick Cunningham: Hi. Thanks for taking my question. On the Pest Elimination business, the sales growth continues to be very strong, but the margin expansion is a bit more muted than the other segments. How should we think about the cadence of growth investments into that business and the timing on when we start to see some meaningful sales leverage and just a follow-up there is, what sort of long-term margin target do you have for that business? Christophe Beck: Good question, Patrick. So I really love that business, very steady growth, high single, low double, really good, not always an easy market, but whatever happens out there, it's always a very good performance. At the same time, it's the best performing Pest Elimination business in the world, which is also a good indication. And as you know, so there is no raw materials, almost none related to that business. So there is no DPC help or hurt obviously on that business. It's a business that's going to get north of 20%, for sure. And when I think about the main growth drivers here, there are two mostly. The first one is to drive cross-sell, which has been at core of our growth strategy in Pest Elimination, so selling the Pest Elimination services to existing Ecolab customers worked really well over many, many years. And second, it's to invest in connected devices. We have all the technology. We are one of the largest industrial cloud in the world. We have all sensing technology. We have all systems, we have all cybersecurity, everything that you need. Ultimately, so to connect all those millions of devices around the world that today, we go and visit regularly each of them to check whether you're going to get activities or not, well, tomorrow that's going to be very different. One data point at the National Restaurant Association Show we were in that big conference hall, where you have 600 traps in there today, we need roughly eight hours to go and check all those traps. Tomorrow, it's going to be done in 20 minutes. So just imagine how much value we can create, both in terms in terms of growth, of service to customers and naturally in terms of performance that we can drive out of the business. So that's going to drive top line growth. It's going to going to drive earnings growth, and it's going to drive return on invested capital, which is already the highest in our company even further higher. Operator: Our next question is from the line of Andy Wittmann with Robert W. Baird. Please proceed with your question. Andy Wittmann: Great. Thanks for taking the question this afternoon. I guess I also wanted to ask on the 1 Ecolab plan just because from the outside, it's hard to I think, understand sometimes the difference between your various plans. I think over the years, I think back to like the 2018 efficiency initiative, you talked about some of the technology investments that you made enabled those changes then, you expanded that in 2019 and then again in 2020. The institutional advancement program that you rolled out in 2023 was largely underpinned, I think Christophe about the digital investments that you made at that time as well. And then I think even the European program that you announced in 2023 also was kind of driven by digital. So this one I'm hearing again is going to be using technology to effectuate some of these efficiencies, but I mean, can you just make a little bit finer point on kind of what's different about this one compared to some of the prior ones? Christophe Beck: So the main difference, Andy, is that the prior ones where by individual business. It was to really improve the delivery and the performance of Institutional. From a growth perspective, you've seen the results. That's why it's working so well today. It's the only reason. Obviously, we talked about innovation as well here, but the way we've organized ourselves, the way we've leveraged technology, well has been leading to these great performance that we have in Institution and Specialty today. You look at Europe, it was also technology, but it was much more back-office technology. It was much more ERP, Andy. And when you look today, well, Europe came from 0% margin to 13%, 14% today. So a very solid good business that we have there. 1 Ecolab is connecting all the businesses together in order so for our customers to see 1 Ecolab and for us to help them understand by leveraging all Ecolab can do, what's the value, what's the savings that me as a customer can expect if all my units were at the best performance level of all my locations, how much would that be? It's a different dimension because this one, Andy, is connecting businesses together the previous ones whereby individual businesses that all led to very good returns at the same time. Operator: Thank you. Our next question is from the line of Mike Harrison with Seaport Research. Please proceed with your question. Mike Harrison: Hi, good afternoon. You noted the high-tech business within the Water segment is growing double-digits. Christophe, is there any way to be a little bit more specific? Is that a teens growth rate or more like 20% or 30% or even higher? And can you talk about the penetration rate with data centers? Or any other context around the opportunity that you're seeing around data centers over the next few years for your Water business? Thank you. Christophe Beck: So it's been in 2023, so that business, which is a few hundred million, as we've talked about, has been growing some in the 30%-ish like that. We're not disclosing too much detail so far. It will come when we have a more steady states organization and platform to serve that new industry, we will share that, obviously, with you, but kind of a few hundred million growing roughly 30% last year, what it's showing you kind of the trajectory that we have in that business. At the same time, it's a very highly profitable business because the customers we serve, which are the high-tech companies, being semiconductors, manufacturers or data centers, hyperscalers operators. Well, those ones are not looking for the most cost-efficient solution. They are trying to find partners that are helping them deliver the highest uptime, the highest power of computing, while reducing the usage of water and energy because that's the true limiting factor and that's where we invest all our resources on innovation in order to help those companies produce more computing power while reducing the impact on the environment. So the cost of it is kind of secondary which means we can invest in high technology. They pay for it. It's good for them. It's good for us. It's good for our shareholders as well. This global high-tech business has been a fantastic business and keeps getting better. Operator: Our next question is from the line of Vincent Andrews with Morgan Stanley (NYSE:MS). Please proceed with your question. Q - Vincent Andrews: Thank you. One more on the One Ecolab and Christophe, you noted that this program is designed for all of your segments. I'm wondering if you can just touch on within the different segments, are there some where you anticipate having a greater impact on volume or a greater impact on price? And overall, are there some segments that you think it will benefit more than others? A - Christophe Beck: It's an interesting question, Vincent. There is one that I could share with you. When I think about F&B, as we speak, so we are bringing our food and beverage, cleaning sanitation business together with our water F&B business. And don't get me wrong. It's not that suddenly we'll have at the frontline people doing both water and cleaning and sanitation. They go hand in hand, but they are complementary, like you would be in a hospital, you have several physicians that are serving you as a patient. We believe in expertise. We don't believe in generalist. But that business, which will include our cleaning and sanitation and water together, well, is one of our biggest business, one of our best franchisees as well in the world. And I believe that's going to drive a lot of further value for our customers and for us and our shareholders, obviously here. But you can think as well about institutional. When you are a restaurant chain, so with thousands of restaurants in the country or around the world, knowing what's potential of performance improvement in dollar terms that I can get if all my restaurants were performing at the best performing one. Well, that's huge insight. What's even more important. So with us is that we can deliver that performance because we've delivered it for the best-performing unit as well at the same time. And the fact that we shared then afterwards the upside for the customer what that drives mostly value price, which is not the least price, which is mostly seen in other businesses. I mean, in other companies. For us, value price, and that's why we call it that way. It's our share in the improvement that we are delivering to our customers, which is why it never goes down by the way and we keep going up as we move forward as well at the same time. So, a very good story for all businesses. Food and beverage is an obvious one and institutional another one as well. So ultimately, this is bringing our strategy of circle the customer, circle the globe in ways that are much more hard wired than the way we did it in the past where we can share the knowledge of Ecolab anywhere around the world across all businesses and industries. Well, that's a critical reason why I believe that in the quarters and years to come, we will keep delivering day in and day out and get towards our targeted performance of the 5% to 7% or 20% OI margin and 12% to 15% 0earnings per share growth as our next step of performance. And again, that's not going to be the last step. This is our next level of performance that we're all working hard to deliver as quickly as we can. Operator: Thank you. Mr. Hedberg, there are no further questions at this time. I would like to turn the floor back to you for closing comments. Andy Hedberg: Thank you. That wraps up our second quarter conference call. This conference call and the associated discussion slides will be available for replay on our website. Thanks for your time and participation, hope everyone has a great rest of your day. Operator: Ladies and gentlemen, thank you for your participation. This does conclude today's teleconference. You may now disconnect your lines, and have a wonderful day.