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Earnings call: OpenText's cloud focus and AI integration drive growth By Investing.com
OpenText (OTEX), a global leader in information management solutions, recently held an earnings call to discuss its financial performance and strategic direction. The company emphasized its commitment to cloud expansion and AI integration, which are expected to contribute to growth in cloud bookings. Despite a strong performance in content and cybersecurity products, OpenText experienced a miss in Q4 due to lost selling time associated with the divestiture of Micro Focus. However, the company remains optimistic about its future, projecting substantial growth in EBITDA margins and free cash flow by fiscal year 2025, and setting long-term targets for 2027. OpenText's strategy is centered around leveraging its cloud and AI capabilities to manage the high volume of unstructured data in enterprises. This approach is designed to meet the growing demand for solutions that enable companies to prepare for AI and solve complex problems. With a focus on operational efficiency and margin expansion, OpenText is positioning itself for long-term growth and value creation for its customers and shareholders. The upcoming OpenText World event will provide further insights into the company's strategic initiatives and operational plans. OpenText (OTEX) has demonstrated a consistent commitment to shareholder returns, with the company raising its dividend for 11 consecutive years. This is a testament to OpenText's financial health and its management's confidence in the company's cash-generating ability. The recent earnings call highlighted the company's optimism for future growth, and with a dividend yield of 3.3% as of the last twelve months ending Q4 2024, investors may find OpenText an attractive option for both growth and income. In terms of profitability, OpenText's gross profit margins stand out at an impressive 76.87% for the same period, underscoring the company's ability to maintain high levels of efficiency in its operations. The company's valuation also implies a strong free cash flow yield, a key indicator that many investors look for when assessing the value and potential of a stock. With analysts revising their earnings upwards for the upcoming period, OpenText's financial outlook appears robust. For readers looking to dive deeper into the company's financials and future prospects, there are additional InvestingPro Tips available, offering a comprehensive analysis to support investment decisions. In total, there are 9 InvestingPro Tips for OpenText, available at https://www.investing.com/pro/OTEX, which can provide further valuable insights into the company's performance and market position. Steven Enders: Well, thanks, everybody, for being here. I think we're at the last session of the day for day 2 of the Citi Technology Conference. I'm Steve Enders part of the software research team here. With us today for, I guess, the last session today is Madhu from OpenText. Madhu, thank you so much for being here. Q - Steven Enders: Yes. So maybe to start off, I think OpenText has gone through a pretty -- a lot of changes in the past few years. Clarification, acquiring Micro Focus, divesting parts of Micro Focus and a recent restructuring. So maybe can you kind of walk us through that journey and maybe how is OpenText as a business different today than it was a few years ago? Madhu Ranganathan: Yes, absolutely. As you rightly pointed out, we've gone through many changes. We've gone through dramatic changes. I'll start here. We are a relatively software company at 33 years old. And our growth historically has been driven by value-driven acquisitions and by organic growth. I do want to put an emphasis on cloud, especially to your question about what is different today than the journey of OpenText. Several acquisitions have contributed to the foundation of OpenText in content, in business network, in cybersecurity. The most transformative acquisition is what we closed in January 2023, that's Micro Focus. And now thinking of Micro Focus X, the mainframe business AMC, which we divested, is really where we are as an information management company. And what I would say is when we think about data in enterprises, data that's stored, data that's moved, data that's secured, all of that is managed by OpenText, and that's the right way to think about it. So we are focused on our top priorities where we sit today. which is really deepening and expanding our competitive advantage, growth in the cloud, cloud acceleration. . We have done very well. We had a very good fiscal '24 in terms of our full year of integration of Micro Focus. So we are well on our path of margin expansion. And lastly we can talk more about it, is we are back into very strong capital allocation driven by dividends and share buybacks. So where we are today, that's different, given all the rapid journeys, I would put a stronger emphasis on cloud, Expect to hear more from us from a cloud perspective. And also, as I said, we have always been unique in terms of operational efficiency and profits, and we're going to continue to be on the path. Steven Enders: Okay. Now that's -- it's a great place to start. I think maybe think about OpenText, the roots are in kind of ECM, content management. You've talked a lot more about information management. Can you maybe just talk about that transition and kind of everything that you would kind of include in that information management umbrella? Madhu Ranganathan: Yes. So in our most recent earnings presentation, it's specifically Slide 7 of our investor deck, you will see how we've broken down our revenues, which is really our product groups and our markets. So it's content, is about 40%, and cybersecurity is 20%, business network is 10%, IT operations management is 10%, application automation is 15% and analytics is 5%. Now think about these in the context of what I said earlier on the cloud, which is it's led by content, business network and ITOM, but really think about all of them are business cloud. Some are more advanced from a cloud perspective than the others. But those are really the opportunities for us. Again, we can talk more about fiscal '27 when we speak about 7% to 9% growth. Content has seen a lot of R&D investments for cloud and is on its path to be very strong in the cloud. Cybersecurity has a lot of cloud in it. ITOM is early in the cloud. Application automation is early in the cloud, right? And business network has always been in the cloud. So depending on where the different product groups are -- but that's how we're defining information management, right? It's content, it's business network, cybersecurity, ITOM, IT operations management, application automation and, of course, all wrapped around from analytics. And actually, you have a question on AI, we can talk about it, but AI is a real calling for us to continue the growth in the cloud and in many different directions. Steven Enders: Okay. Yes. I definitely want to touch on AI in a bit. I think maybe before we get there, a lot of areas in the portfolio, can you maybe help us think through kind of what are the -- where you would consider the growth of your areas, where you see kind of the opportunity and which maybe are a little bit kind of more mature and you're kind of managing through some of those? Madhu Ranganathan: Yes. So with cloud being a leading growth driver, think about content as very well poised and continuing to report and we're thinking about disclosures down the road, very strong growth rates in the cloud, right? Business network, again, it's very sector focused. We serve industrial, we serve automotive. We serve the pharma. And given the strength of the sector, you will see the strength in business network as well. We are driving security and AI across our business clouds, and that's going to remain a growth driver. I mean most important is what I would say, new use cases are emerging, and those use cases are going to require any form of cloud that we offer. We offer private cloud, we offer public cloud and we offer SaaS. We actually finished our fiscal '24 with a strong organic growth rate in the cloud, but more importantly, in Q4, we saw slightly over 3%. And all of these growth drivers are going to contribute to the 2% to 5% in '25 and 7% to 9%. Our leading indicator remains the cloud bookings growth, right? When you look at our 25% growth rate, we're looking at over $900 million of enterprise cloud bookings in fiscal '25. And that's at the heels of about $700 million previous year, $530 million in the previous year. Again, all of this is -- today, cloud is about 35% of our revenues. And when you look at our fiscal '27, it's going to be well north of that, right? So those are kind of the key areas from a growth driver perspective. Steven Enders: Okay. That makes sense. I do want to ask about the -- some of the optimization initiatives, and I think you had about 2% RIF in July. I guess what led that change? How do you think about the focus areas of reinvestment from here? And I guess, kind of any implications this has on the margin trajectory? Madhu Ranganathan: Yes, absolutely. Look, many companies have different reasons for their restructuring and optimization Ours is a very relentless focus on how efficient can we be at the scale. So the 36% to 38% in '27 upon a $5.7 billion to $5.9 billion revenue range, that is our measure of efficiency at that size and scale. Now coming about 18 months off of the Micro Focus acquisition, we saw opportunities to be in that efficiency path. The restructuring was focused primarily on the U.S. workforce and moving our talent to what we call the centers of excellence. Our centers of excellence are centers where there's market for the talent. We can hire at the rate that we want to. And of course, there could be a cost differential, right? So our centers of excellence are India, are Romania and Canada, and that's really the shift we made. Now we maintain the U.S. workforce in areas like professional services, sales, so the reinvestment we made, think of them as back carriers. As quota carriers. It's the best reinvestment you can make, right? And you have to make it much in advance. So these are sales reps, these are renewal reps and these are professional services reps. Now from a margin expansion perspective, we focused on the reinvestment starting from the beginning of the fiscal year. So think of it as us carrying costs for the entire year. So that's also why we expanded the margin 100 basis points and not more than that. But the benefit of that is going to come through to our fiscal '27 path of the 36% to 38%. Steven Enders: Okay. All right. That's a great context there. There's been some leadership changes, brought in some new go-to-market leaders. I think you yourself took on a bit of a promotion here. So congratulations. Steven Enders: But I guess what has changed from an execution standpoint? And are there other shifts underway with the new leadership coming in? And how do you kind of think about some of the, I guess, near-term execution? Madhu Ranganathan: Yes. So again, different companies have different org structures, but I'd like to speak to the 3 president structure as one that was needed for the size and scale of OpenText. Now let's talk about sales. Prior to this, Todd Cione is the President of Worldwide Sales, we had about 5 theaters reporting into a CEO directly, right? So this is the right time at the heels of Micro Focus coming out of an 18-month great integration framework to appoint Todd as the Worldwide Head of Sales. Paul Duggan, he runs all of renewals, and he also runs the cloud services business. So think of him as cloud once the cloud booking is done, he's responsible for the delivery of the revenue and of course, a very marquee installed base. Now these 2 growth revenue organizations, the leadership there is really intended to bring unification to the renewal side, unification to cloud deployment and unification to the selling organization, right? And we have various product groups, as we just talked about earlier and this is really going to be very instrumental. And the unification is important is how you think about value proposition for a large customer, right? And having that across the pillars is very important. And both of them bring tremendous years of enterprise selling experience, and we couldn't be -- and we could be more excited. And as for myself, the add has been twofold. One is just leading operations throughout the company more officially, so to speak. And I always was seeing that as part of the role now just taking an operational lens throughout the company, and that's going to be very integral to our march towards upper quartile EBITDA margin and, of course, taking on corporate development as well. So that includes the AMC divestiture, includes TSA with AMC. And we're excited to be more into the tuck-in M&A process from a corp dev perspective. Steven Enders: Okay. I guess maybe this is a good time to maybe talk a little bit about the cloud opportunity and kind of the AI side and how you're thinking about that opportunity there. Maybe we can just start on kind of the cloud side. I think cloud bookings has seen some pretty impressive quarters here the past couple. But I don't think we've necessarily seen that translate yet to the revenue side. Can you maybe help us kind of bridge the gap between the, I think, 33% bookings growth you saw in '24 versus the kind of 2% to 5% '25 cloud revenue growth guide? Madhu Ranganathan: Yes, yes, absolutely. It's a question we get asked often, and it's one that's very important. What the booking does is give us forward visibility. We shared a quarter ago in our earnings call that our cloud contracts are getting into a median or an average of 4-year tenure versus 3 tenure. And that means a lot, right? So our ramp time for the OpenText Enterprise cloud, particularly in the private cloud side, just the ramp time could be as long as 6 to 9 months. And then, of course, there are leading applications that enterprises think about when they purchase -- and OpenText solution is not just purchased on its own. It's purchased on the heels of a CRM. It's purchased on the heels of an ERP. So I say that those horses leave the barn before we do, right? So the ramp time could be as long as 6 to 9 months. And then, of course, we start the deployment and the curve goes a bit sort of slower and then very fast into the third year or the fourth year. So think of these bookings as giving us visibility and strength into the 2% to 5% of fiscal '25. And to the 7% to 9% of fiscal '27, right? So we look forward to like sometime in fiscal '25, to coming with better correlation, algorithm, so to speak, on how do you take the bookings to revenue. That has been an important aspect that we obviously track very detail internally, but we'd like to give investors a consumable model to that. But we couldn't be more excited about the visibility and the strength of bookings. The last thing I'll say is our cloud bookings, they're all noncancelable. So over the term of the 3 years or the 4 years and in some cases, even longer, right, we end up receiving the full benefit of those bookings. It's just a matter of time. Steven Enders: Okay. That makes sense. I mean it does feel like you are seeing pretty good just general strength on the cloud side based on the execution in '24, but also I think for '25, you raised the guide on cloud bookings now to 25%. So I guess, what are you seeing from a new demand perspective or migration activity that's given you confidence in this elevated level? . Madhu Ranganathan: Yes. And you asked the question in your earlier comments, so let me just expand on it. And we've said this in the last few quarters. the AI wave was really helping OpenText to expand its cloud bookings. The volume of unstructured data that sits in enterprises still remains very, very high. And customers are very keen to what we call organize for AI or prepare for AI. That is really the strength that you're seeing in our cloud bookings. We're having hundreds of conversations in AI. AI is part of every cloud conversation. As I spoke about it earlier, there are new use cases, they're thinking about new workloads. But for our business model, it's really bifurcated into two phases: one, preparing for AI, the strength of the cloud bookings and the actual AI revenues itself, which we're not calling out yet, right? We are product ready on the Aviator, which is our AI products. And Aviator product is really launched in every one of our product groups in content, in cybersecurity and ITOM, et cetera. So I would say the big demand drivers remain the customers wanting to be ready with respect to AI. And the second piece I will outline that's probably unique to OpenText is, our customers are talking about very large complex problems, right? They're not talking about kind of the smaller use cases. So that, again, is an important tailwind for us. And I would say a minor point, please think of the cloud growth rate as an annual growth rate, right? We do have certain quarters where we do really well. So the 33% at the heels of that, I would put out 25% vis-a-vis a 15% starting point we had about 2 quarters ago that we were able to take it up to 25%. So I think in summary, I would say, preparing for AI, really large complex problems that the customers are trying to solve and organizing for AI that's creating these demand drivers. Steven Enders: Okay. Maybe we can talk a little bit now that we're on the topic of AI. How should we -- you've already talked around like people are getting ready for AI, and that's beginning to impact things. But I guess, how should we be thinking about kind of the next level of AI monetization, where people are leveraging OpenText AI and Aviators and all those kind of other products that you've been coming out with. Madhu Ranganathan: Yes. So we began to be product ready last October. And the aviator products themselves have come through a few evolution points. As I said, we're having hundreds of conversations. They are also translating into customers kicking off pilots and we noted Bosch as an important customer. We noted a large retailer that's thinking about a $50 billion of contract value in terms of AI. So the key thing here has been introduce what we call our Aviator Thrust offerings and grow our Aviator Thrust offerings. We have the sales team ready. We have the professional services team ready. So look to us to speak more about these pilots, to the use cases from an AI Aviator perspective, that will eventually turn into, I mean like turn into monetization. But more importantly, I think as you outlined earlier, we see the tailwind of this helping us in our cloud bookings. And that's really why we can see the 25% growth which again, if you do the math, it's well over $900 million of cloud bookings in the year, and we're actually quite excited about it. Steven Enders: Yes. No, it's pretty impressive growth. I think you did -- you've talked about some of these early wins, but maybe we could talk a little bit more around the actual use cases that people are coming to OpenText to help solve for leveraging those AI. Like what do those look like? Or how do you feel like you're actually helping the customers leveraging your AI solutions? Madhu Ranganathan: Yes. So a few comments there. The right to AI, we really think about it as the readiness for AI, as I talked about. We are just more than ready. For our customers, there's no vendor better than OpenText to deploy AI just given they have trusted us with their content and data, in many cases, multiple years or multiple decades. Customers are looking at optimizing like literally their $1 billion supply chain, right? And when you look at this volume of contracts where AI can be applied, you're talking about $50 billion worth of contracts where, again, the customers are deploying -- are thinking about pilots at the moment, but it's going to be what we call the steady, steady and somewhere an inflection point, right? And in the business network, for example, automotive, et cetera. They are looking at every single trade that can be optimized through that -- through the application of AI and Aviator. So whether it's a content customer or a BN customer, that's really where we personally are excited in the importance of how OpenText rolled out Aviator by the product group. We made it easier for the customer to not think too much about where the product would fit, but to think more about what problems and use cases that they're trying to solve, right? And stay tuned and more to come on that. Steven Enders: I'm sure we'll hear more at the -- your conference in next month or... Madhu Ranganathan: It's in November. I mean I was going to say, the product teams or sales teams are absolutely going to showcase all the product innovation and AI is going to be a key theme. It's in November 18 and 19, and you'll hear more from our IR teams. Steven Enders: Okay. Perfect. No, I'm sure we're all excited and ready to see what comes out of that. Maybe shifting gears slightly, understanding the AI solutions. It sounds like it's having good performance on it. But maybe what does the macro backdrop look like today? Are customers at a point where the budgets are unlocking, they're beginning to put dollars to work for AI? Or what is kind of the general OpenText customers budget look like today? Madhu Ranganathan: Yes. So I think one unique aspect about us is we don't speak about macro too often. And here are a few reasons for that. The macro is uneven for all customers. But for us, what we found is that a very positive macro background or a very challenging macro background, our customers are always sort of in the business of revenue augmentation or cost optimization. So our solutions become mission-critical from an enterprise perspective. And what I would also say is that the demand drivers we've talked about have remained very consistent for our customers. And whether it's private cloud, it's public cloud or SaaS, where they really look for is the value proposition in their environment, and that's really where our solutions are focused on. Our sales dialogues are kind of geared towards that. I would say, from a financial model perspective, we have assumed no improvement in interest rate environment and no improvement in the FX environment, which again, if there are green shoots on either side, we are certainly going to be able to do better. And the last one of the most important point, the breadth of our business model, the various product groups, we always find gives it an inherent resilience to macro, right? The business network could have macro impact from automotive or energy, oil and gas, but then content could be doing really well, right? So our growth rates are really predicated on sort of -- I mean, a combined influence of the macro. So we come out more resilient to the macro environment just given the nature of our solution as well as I would say, somewhat of a built-in resilience within the product groups as they're sort of the reaction to the macro. Steven Enders: Okay. I guess maybe digging in a little bit more for the different segments. Maybe where are you seeing a little bit of strength right now, maybe things are a little bit softer. Any way to kind of help frame what that's looking like? Madhu Ranganathan: Yes. So from a product group perspective, content to school again, our content is running very strong, right? And we see that runway quite far. And cybersecurity is a very important pillar for us and both on the enterprise side we called an SMB headwind. We're not quite calling it anymore. But as it turns into a tailwind, I think that certainly could be very supportive for us. But think about ITOM, and our solutions here certainly ServiceNow (NYSE:NOW) is the big gorilla out there, but we are in very exciting early stages of our service management solutions. So I think, Steve, many of our products are especially ones from Micro Focus, where we are relentlessly focused on getting those declines to flat to flat growth, right? So the product innovation, the go-to-market efforts inherent in all of that is going to be our own growth drivers, so to speak. Steven Enders: Okay. Makes sense. On the Q4 performance, I think things maybe were a little bit choppier this quarter. Can you maybe kind of walk through what happened, I guess, what that looks like going forward? And I guess, kind of like what's fixable from that perspective? And how do you feel like the business is positioned to move forward here? Madhu Ranganathan: Yes, absolutely. I'll take it from the last point of your question, the business is positioned very strong. Look, Q4 marks the last quarter of our fiscal '24, and we truly had an outstanding '24. Specific to Q4, the miss was on license, and the miss was on Micro Focus license. And what we found in the quarter was it was the same sales reps, account execs of Micro Focus who were speaking with the AMC customers about the divestiture that happened and how they're standing within OpenText still remain very strong. So if you really think about it, sales teams are all about selling time, lost a bit of selling time. We haven't lost the deals. We haven't lost the business and customers are well grounded, but that did contribute to a miss in license and Micro Focus license in Q4. Now Q4 turned the corner very nicely on our cloud organic growth. We were slightly over 3% in Q4. It was kind of the highest in the year. And we are assuming the trajectory into fiscal '25 at 2% to 5%. Again, we should measure the business and annual bookings growth rate. So the 33% is very strong, and I would point to the 25% in '25. So Steve, 25% is going to be marked by another second year built upon the strong scaled company with Micro Focus, the debt burden eased a bit with the delever of the $2 billion, right? And we can talk more about cash flows, but it's going to start the trajectory of growing cash flows. We are expanding EBITDA margins. So we look at fiscal '25 as it's a very strong foundation going into '26 and '27. Steven Enders: Okay. I do want to ask about the kind of ramp here in the new medium-term guide that you laid out. I think before we get there, I guess you talked a bit about the selling time lost in Q4. I guess, as we think about the changes that got put in place here so far in 1Q and the RIF and some of the changes in go-to-market leadership. I guess do you feel like there's any kind of -- any incremental risk that kind of comes from those changes? Or how should we think about what that means for the business in 1Q? Madhu Ranganathan: No, thank you for the question. And look no incremental risks and we believe only incremental benefits. Todd Cione has already hired quite a group of very strong sales leaders into various parts of the business. And we are very pleased with the hiring and as all of them ramp up is to bring the organic growth, selling DNA more and more into the business, right? We have to become more efficient given the scale and the restructuring we did, which is the first step towards that. We are investing a lot into our centers of excellence to actually get them even more productive and value-adding at a global scale and whether that's Canada or India or Romania and that's part of our plan. So I would say think transformative Micro Focus, divest of AMC, bringing OpenText along. We've kind of really stabilized and strengthened the company to what we need to deliver in '25 and beyond. Madhu Ranganathan: And maybe if you don't mind, I'll just add. We talked about Paul Duggan, and particularly on the renewal side. Paul is launching, as he shared in the earnings call, I mean a digital renewal center, right? And renewal is $2.4 billion plus of business. And that's a very important step in turning the renewals from a renewal to expansion, and we can talk more about that if you'd like. But again, the changes we made, look, changes are hard, but we're very thoughtful about the changes we made, and these are absolutely going to strengthen us to grow, strengthen us to expand margins. and expanding margins is really going to put a better lens towards capitalization as well. Steven Enders: Okay. No, that's great. Yes, maybe we do ask about the expansion and renewal potential of the business. And I think that historically, there's been focus on Micro Focus and trying to get that to kind of corporate average there. So how should we be thinking about what the implications are with the sales changes on retention rates and renewals moving forward? And how are you all thinking about the changes actually being put in place to drive that motion? Madhu Ranganathan: Absolutely. Think of us a few steps behind what the industry has always spoken about like net renewal rates and expansion rates, right? So we are looking forward to bridging that gap. Look, the Micro Focus renewal journey was a great milestone in '24, but not quite done yet. We do want to get Micro Focus into the low 90s, right? So the net renewal rate has been in the works for a while, and it's obviously led by Paul Duggan. And we finished our renewal rates at 95% off-cloud, 92% cloud. If we had applied the expansion rate, they would actually be in the mid-90s, right, from a cloud perspective as well. Now all companies generally capture consumption and expansion. We captured consumption, we haven't captured expansion and which is what we look forward to bringing together to share. And that's where the real growth is the renewal reps in our business are not just responsible for renewing at a principal value they're responsible for adding workloads, right, adding premium rates. And we actually call it the customer success organization, and Paul has actually implemented new customer success tiers, which you will see in the expansion. And we believe '25 is the right time to do that. We're slightly behind, but we're looking forward to catching up. Steven Enders: Okay. No, that makes complete sense. Maybe we can switch gears a little bit and talk a little bit about the margin profile here. I know there's been a lot of changes in the business. So maybe we can just talk -- just start on the short-term cash flow nuances or the interest expenses and kind of what the path to improving EBITDA and EBITDA conversion looks like from here? Madhu Ranganathan: Yes, absolutely. So for fiscal '25, we're looking at 33% to 34%, right? EBITDA margin, adjusted EBITDA margin. Now when you actually look at fiscal '24, it was $2 billion of adjusted EBITDA dollars, that's 34%, right? Now the margin expansion from 33% to 34%, 36% in '26, and 36% to 38% is going to be contributed in a few different angles. From an OpEx perspective, we rightsized in early July through the plan you just mentioned. I talked about cloud gross margin. It's a very important lever to the EBITDA margin. A trough on cloud gross margin was 59%. We picked up in Q4. We are modeling low 60s in fiscal '25 and with some of the efficiencies and growth in revenue and scale and a better product mix of SaaS, which is also part of the engineering innovation. We do expect cloud gross margin to contribute. From an OpEx standpoint, we talked on the call about being more efficient in sales, having a AI Aviator to help out in our sales process and have engineering, have specific projects on automating QA all of that. So increasing those efficiencies actually going to get us to the 36% to 38% gross margin, of course, helped by the top line as well. Now that's going to translate to $1.2 billion to $1.3 billion in free cash flows, right? Our distribution of free cash flow our capital allocation is 50% dividend and buybacks. And at the moment, we believe our stock is the best buy. So we are actively in the share repurchase program we announced. And getting to $1.2 billion to $1.3 billion, expect the capital allocation on the remainder of the 50% will continue to decide between, as you rightly said, dividend, debt reduction share repurchases and selective M&A. Steven Enders: Okay I do want to come back to that topic. But before talking about that, you have those fiscal '27 targets out there. And I think one of the questions we've still been getting, especially on the cash flow side is kind of help us bridge the gap between where things sit on the free cash flow today versus that '27 target. So can you maybe just kind of walk through the onetime things that are kind of in there and kind of bridge the gap between those 2 numbers? Madhu Ranganathan: So the $575 million to $625 million we have for fiscal '25. It's a bit burdened by the tax gain in the AMC transaction and that's about $250 million. And again, we have to think about it as coming off of the proceeds, but it's going to hit the free cash flow this year. So if you were to take the midpoint and you sort of get up to more the $850 million range, that's really the path from the $850 million over to the $1.2 billion to $1.3 billion, right? And as EBITDA improves, our cash flow conversion from the EBITDA is also going to rise from somewhere in the 40s today into the upper 50s, and that's what's going to contribute to the free cash flow. Two important aspects here, including Micro Focus. Our working capital remains strong. right? Going from profitability to our operating cash flows, our working capital remains strong. We brought Micro Focus on to our working capital parity as you see from the DSOs and other metrics that we share. And notwithstanding the cloud growth, our CapEx also remains efficient, right? We've remained at around 2% -- 2% to 3% of revenues on CapEx and we're going to stay at that. And maybe a word on that is making our cloud operation more efficient is going to mean in the private cloud, our own data center footprint being more efficient and also leveraging the hyperscalers, right? So that's how we think about that, Steve. I think more in the $800 million range in terms of free cash flow as a starting point, if you want to talk about '25, '27. And then ramping up the EBITDA and then ramping up the conversion rates, but founded on strong working capital and CapEx efficiency. Steven Enders: Okay. All right. All that makes sense. I do want to talk a little bit about the shift in the strategy a little bit in terms of how you're thinking about M&A. I think historically, think about OpenText. It's been a pretty big acquirer, and there was some digestion that happened here. And now it seems like instead of going full on the M&A bucket, it's more on kind of tuck-ins and some smaller things. So can you talk a little bit about how you're thinking about what that actually means from an M&A perspective to be part of the capital allocation plan. And what are kind of the criteria that you would be looking for in a potential target now? Madhu Ranganathan: Yes. Yes, absolutely. Look, we are in a bit of a unique position that is not a very highly desired position, which is for all the things we've done and where we stand and what we have in terms of future product and growth and market opportunities, we do remain tremendously undervalued. So we prioritize share repurchases as top of the house from a capital allocation perspective. I think your term is right. I think it is about digestion. And for us, the digestion means getting the Micro Focus products back to more organic growth. Upping the renewal rates and clarification, we never did the Micro Focus transaction for their license business. We did it for the opportunities to cloudify and that was a 10-year journey for OpenText is probably a shorter journey as we look ahead. So that clarification of Micro Focus products is also part of the digestion process opportunity ahead, right? So all of those in front of us, we remain -- we believe our stock is -- I mean, our stock is the best buy. Look, we have a lot of muscle memory on M&A. That's an understatement, right? So we will be in the M&A market, but down the road as we get into a better currency from a stock perspective, improve the cash flows. And once again, we remain cognizant of the debt, so we'll keep evaluating the 4, which is, of course, dividend, repurchases, debt reduction and M&A. But when all of that currency improves and the right transaction comes in at the right value and the right value to us and the right value from a market perspective, we would not be hesitant to engage in it. Steven Enders: Okay. I know we've kind of already touched on capital allocation a little bit. And like there is the view that the stock is cheap, so let's go buy it. But how are you thinking about -- well, you do have the plan already in place on that part. But how does that plan maybe come together? And how should we think about maybe what the right mix looks like moving forward between buybacks, dividends, M&A and also continuing to kind of delever the business? Madhu Ranganathan: Yes. So as I said earlier, we haven't really modeled any improvement in interest rates, right? So the -- or sort of the average portfolio is still about 6%, and they still appetite to optimize that. So look, we have been a consistent dividend payer and look for that to continue, right? But between the other 3, we would definitely keep doing the math and the modeling around can we delever even more. We're delighted we delever 30%. Can we delever even more. Is the 2.9-ish the right net leverage ratio, could be lower than that. right, of course. And I think share repurchases as long as the stock is around these levels, we'll continue to prioritize share repurchases. The type of M&A we look at was also your question, our lens is definitely cloud-related M&A, right? And we can talk a lot about this, but we're not going to compromise on our cash flow targets, profitability targets, but grow your assets if they come at a reasonable price, and add to the organic growth of OpenText. And where we can bring our excellence in operations to those grow your assets and keep our customer target, we'll certainly entertain that. So I would say the measurement really is the value of the stock, is the cost of the debt, right? And how fast or how much can an asset add to our growth and add to our cash flows. Steven Enders: That makes sense. You mentioned the leverage ratio. But I guess why is this kind of the right area, 3x, 2.9x. Why is that kind of the right area for OpenText to be at? Madhu Ranganathan: So at a lower scale company being below 3 was sort of the right -- was sort of the right area zone for us. And at this point, I would say we are delighted with the 30% deleverage we did, but should the right opportunity present itself to delever even more, we will. And as you can appreciate, it's definitely a drain on the cash flows, right? And the more we can optimize the free cash flow, the opportunities open up as we just talked about in terms of M&A as well. So that's sort of how we think about the use of the cash flows. Steven Enders: Okay. Right. Makes sense. I think we're running up on time here. We've got about a minute left. But I do want to ask about OpenText World in November, so I appreciate the clarity on that one. I guess, what should investors be paying attention to at the upcoming conference? Madhu Ranganathan: Yes. So we welcome wide distribution of the content information, and we are looking for very strong attendance. We did something similar last year and Harry and the team did that. It was very well received. So here's what I'd leave you with, right? You hear a lot about the financial profile of OpenText and financial targets in our earnings call and plenty of conversations ensue on that. So at OpenText World, we're looking forward to presenting to you from the sales organization, from the product organization, and there will be plenty of real live product demos. So the 3 areas we'd like you to walk away with is much higher confidence around our product and innovation strategy, much higher confidence and several proof points of our growth strategy. And we're also going to add Shannon Bell, who leads our cloud operation to speak to you about cloud operations and infrastructure, which is important for the growth strategy. It is also important for the financial profile and cloud being kind of the lead growth driver in the future. So those would be the 3 big takeaways with plenty of other bells and whistles around it. Steven Enders: Okay. All right. Well, that's great to hear. I guess we'll look forward to that event. Madhu, I want to thank you so much for being here and the rest of the OpenText team, and I want to thank everybody in the room as well.
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Open Text Corporation (OTEX) Citi's 2024 Global TMT Conference Call Transcript
Open Text Corporation (NASDAQ:OTEX) Citi's 2024 Global TMT Conference Call September 5, 2024 4:40 PM ET Company Participants Madhu Ranganathan - President, CFO & Corporate Development Conference Call Participants Steven Enders - Citi Steven Enders Well, thanks, everybody, for being here. I think we're at the last session of the day for day 2 of the Citi Technology Conference. I'm Steve Enders part of the software research team here. With us today for, I guess, the last session today is Madhu from OpenText. Madhu, thank you so much for being here. Madhu Ranganathan Thank you, Steve, for having OpenText. Question-and-Answer Session Q - Steven Enders Yes. So maybe to start off, I think OpenText has gone through a pretty -- a lot of changes in the past few years. Clarification, acquiring Micro Focus, divesting parts of Micro Focus and a recent restructuring. So maybe can you kind of walk us through that journey and maybe how is OpenText as a business different today than it was a few years ago? Madhu Ranganathan Yes, absolutely. As you rightly pointed out, we've gone through many changes. We've gone through dramatic changes. I'll start here. We are a relatively software company at 33 years old. And our growth historically has been driven by value-driven acquisitions and by organic growth. I do want to put an emphasis on cloud, especially to your question about what is different today than the journey of OpenText. Several acquisitions have contributed to the foundation of OpenText in content, in business network, in cybersecurity. The most transformative acquisition is what we closed in January 2023, that's Micro Focus. And now thinking of Micro Focus X, the mainframe business AMC, which we divested, is really where we are as an information management company. And what I would say is when we think about data in enterprises, data that's stored, data that's moved, data that's secured, all of that is managed by OpenText, and that's the right way to think about it. So we are focused on our top priorities where we sit today. which is really deepening and expanding our competitive advantage, growth in the cloud, cloud acceleration. . We have done very well. We had a very good fiscal '24 in terms of our full year of integration of Micro Focus. So we are well on our path of margin expansion. And lastly we can talk more about it, is we are back into very strong capital allocation driven by dividends and share buybacks. So where we are today, that's different, given all the rapid journeys, I would put a stronger emphasis on cloud, Expect to hear more from us from a cloud perspective. And also, as I said, we have always been unique in terms of operational efficiency and profits, and we're going to continue to be on the path. Steven Enders Okay. Now that's -- it's a great place to start. I think maybe think about OpenText, the roots are in kind of ECM, content management. You've talked a lot more about information management. Can you maybe just talk about that transition and kind of everything that you would kind of include in that information management umbrella? Madhu Ranganathan Yes. So in our most recent earnings presentation, it's specifically Slide 7 of our investor deck, you will see how we've broken down our revenues, which is really our product groups and our markets. So it's content, is about 40%, and cybersecurity is 20%, business network is 10%, IT operations management is 10%, application automation is 15% and analytics is 5%. Now think about these in the context of what I said earlier on the cloud, which is it's led by content, business network and ITOM, but really think about all of them are business cloud. Some are more advanced from a cloud perspective than the others. But those are really the opportunities for us. Again, we can talk more about fiscal '27 when we speak about 7% to 9% growth. Content has seen a lot of R&D investments for cloud and is on its path to be very strong in the cloud. Cybersecurity has a lot of cloud in it. ITOM is early in the cloud. Application automation is early in the cloud, right? And business network has always been in the cloud. So depending on where the different product groups are -- but that's how we're defining information management, right? It's content, it's business network, cybersecurity, ITOM, IT operations management, application automation and, of course, all wrapped around from analytics. And actually, you have a question on AI, we can talk about it, but AI is a real calling for us to continue the growth in the cloud and in many different directions. Steven Enders Okay. Yes. I definitely want to touch on AI in a bit. I think maybe before we get there, a lot of areas in the portfolio, can you maybe help us think through kind of what are the -- where you would consider the growth of your areas, where you see kind of the opportunity and which maybe are a little bit kind of more mature and you're kind of managing through some of those? Madhu Ranganathan Yes. So with cloud being a leading growth driver, think about content as very well poised and continuing to report and we're thinking about disclosures down the road, very strong growth rates in the cloud, right? Business network, again, it's very sector focused. We serve industrial, we serve automotive. We serve the pharma. And given the strength of the sector, you will see the strength in business network as well. We are driving security and AI across our business clouds, and that's going to remain a growth driver. I mean most important is what I would say, new use cases are emerging, and those use cases are going to require any form of cloud that we offer. We offer private cloud, we offer public cloud and we offer SaaS. We actually finished our fiscal '24 with a strong organic growth rate in the cloud, but more importantly, in Q4, we saw slightly over 3%. And all of these growth drivers are going to contribute to the 2% to 5% in '25 and 7% to 9%. Our leading indicator remains the cloud bookings growth, right? When you look at our 25% growth rate, we're looking at over $900 million of enterprise cloud bookings in fiscal '25. And that's at the heels of about $700 million previous year, $530 million in the previous year. Again, all of this is -- today, cloud is about 35% of our revenues. And when you look at our fiscal '27, it's going to be well north of that, right? So those are kind of the key areas from a growth driver perspective. Steven Enders Okay. That makes sense. I do want to ask about the -- some of the optimization initiatives, and I think you had about 2% RIF in July. I guess what led that change? How do you think about the focus areas of reinvestment from here? And I guess, kind of any implications this has on the margin trajectory? Madhu Ranganathan Yes, absolutely. Look, many companies have different reasons for their restructuring and optimization Ours is a very relentless focus on how efficient can we be at the scale. So the 36% to 38% in '27 upon a $5.7 billion to $5.9 billion revenue range, that is our measure of efficiency at that size and scale. Now coming about 18 months off of the Micro Focus acquisition, we saw opportunities to be in that efficiency path. The restructuring was focused primarily on the U.S. workforce and moving our talent to what we call the centers of excellence. Our centers of excellence are centers where there's market for the talent. We can hire at the rate that we want to. And of course, there could be a cost differential, right? So our centers of excellence are India, are Romania and Canada, and that's really the shift we made. Now we maintain the U.S. workforce in areas like professional services, sales, so the reinvestment we made, think of them as back carriers. As quota carriers. It's the best reinvestment you can make, right? And you have to make it much in advance. So these are sales reps, these are renewal reps and these are professional services reps. Now from a margin expansion perspective, we focused on the reinvestment starting from the beginning of the fiscal year. So think of it as us carrying costs for the entire year. So that's also why we expanded the margin 100 basis points and not more than that. But the benefit of that is going to come through to our fiscal '27 path of the 36% to 38%. Steven Enders Okay. All right. That's a great context there. There's been some leadership changes, brought in some new go-to-market leaders. I think you yourself took on a bit of a promotion here. So congratulations. Madhu Ranganathan Thank you. Steven Enders But I guess what has changed from an execution standpoint? And are there other shifts underway with the new leadership coming in? And how do you kind of think about some of the, I guess, near-term execution? Madhu Ranganathan Yes. So again, different companies have different org structures, but I'd like to speak to the 3 president structure as one that was needed for the size and scale of OpenText. Now let's talk about sales. Prior to this, Todd Cione is the President of Worldwide Sales, we had about 5 theaters reporting into a CEO directly, right? So this is the right time at the heels of Micro Focus coming out of an 18-month great integration framework to appoint Todd as the Worldwide Head of Sales. Paul Duggan, he runs all of renewals, and he also runs the cloud services business. So think of him as cloud once the cloud booking is done, he's responsible for the delivery of the revenue and of course, a very marquee installed base. Now these 2 growth revenue organizations, the leadership there is really intended to bring unification to the renewal side, unification to cloud deployment and unification to the selling organization, right? And we have various product groups, as we just talked about earlier and this is really going to be very instrumental. And the unification is important is how you think about value proposition for a large customer, right? And having that across the pillars is very important. And both of them bring tremendous years of enterprise selling experience, and we couldn't be -- and we could be more excited. And as for myself, the add has been twofold. One is just leading operations throughout the company more officially, so to speak. And I always was seeing that as part of the role now just taking an operational lens throughout the company, and that's going to be very integral to our march towards upper quartile EBITDA margin and, of course, taking on corporate development as well. So that includes the AMC divestiture, includes TSA with AMC. And we're excited to be more into the tuck-in M&A process from a corp dev perspective. Steven Enders Okay. I guess maybe this is a good time to maybe talk a little bit about the cloud opportunity and kind of the AI side and how you're thinking about that opportunity there. Maybe we can just start on kind of the cloud side. I think cloud bookings has seen some pretty impressive quarters here the past couple. But I don't think we've necessarily seen that translate yet to the revenue side. Can you maybe help us kind of bridge the gap between the, I think, 33% bookings growth you saw in '24 versus the kind of 2% to 5% '25 cloud revenue growth guide? Madhu Ranganathan Yes, yes, absolutely. It's a question we get asked often, and it's one that's very important. What the booking does is give us forward visibility. We shared a quarter ago in our earnings call that our cloud contracts are getting into a median or an average of 4-year tenure versus 3 tenure. And that means a lot, right? So our ramp time for the OpenText Enterprise cloud, particularly in the private cloud side, just the ramp time could be as long as 6 to 9 months. And then, of course, there are leading applications that enterprises think about when they purchase -- and OpenText solution is not just purchased on its own. It's purchased on the heels of a CRM. It's purchased on the heels of an ERP. So I say that those horses leave the barn before we do, right? So the ramp time could be as long as 6 to 9 months. And then, of course, we start the deployment and the curve goes a bit sort of slower and then very fast into the third year or the fourth year. So think of these bookings as giving us visibility and strength into the 2% to 5% of fiscal '25. And to the 7% to 9% of fiscal '27, right? So we look forward to like sometime in fiscal '25, to coming with better correlation, algorithm, so to speak, on how do you take the bookings to revenue. That has been an important aspect that we obviously track very detail internally, but we'd like to give investors a consumable model to that. But we couldn't be more excited about the visibility and the strength of bookings. The last thing I'll say is our cloud bookings, they're all noncancelable. So over the term of the 3 years or the 4 years and in some cases, even longer, right, we end up receiving the full benefit of those bookings. It's just a matter of time. Steven Enders Okay. That makes sense. I mean it does feel like you are seeing pretty good just general strength on the cloud side based on the execution in '24, but also I think for '25, you raised the guide on cloud bookings now to 25%. So I guess, what are you seeing from a new demand perspective or migration activity that's given you confidence in this elevated level? . Madhu Ranganathan Yes. And you asked the question in your earlier comments, so let me just expand on it. And we've said this in the last few quarters. the AI wave was really helping OpenText to expand its cloud bookings. The volume of unstructured data that sits in enterprises still remains very, very high. And customers are very keen to what we call organize for AI or prepare for AI. That is really the strength that you're seeing in our cloud bookings. We're having hundreds of conversations in AI. AI is part of every cloud conversation. As I spoke about it earlier, there are new use cases, they're thinking about new workloads. But for our business model, it's really bifurcated into two phases: one, preparing for AI, the strength of the cloud bookings and the actual AI revenues itself, which we're not calling out yet, right? We are product ready on the Aviator, which is our AI products. And Aviator product is really launched in every one of our product groups in content, in cybersecurity and ITOM, et cetera. So I would say the big demand drivers remain the customers wanting to be ready with respect to AI. And the second piece I will outline that's probably unique to OpenText is, our customers are talking about very large complex problems, right? They're not talking about kind of the smaller use cases. So that, again, is an important tailwind for us. And I would say a minor point, please think of the cloud growth rate as an annual growth rate, right? We do have certain quarters where we do really well. So the 33% at the heels of that, I would put out 25% vis-a-vis a 15% starting point we had about 2 quarters ago that we were able to take it up to 25%. So I think in summary, I would say, preparing for AI, really large complex problems that the customers are trying to solve and organizing for AI that's creating these demand drivers. Steven Enders Okay. Maybe we can talk a little bit now that we're on the topic of AI. How should we -- you've already talked around like people are getting ready for AI, and that's beginning to impact things. But I guess, how should we be thinking about kind of the next level of AI monetization, where people are leveraging OpenText AI and Aviators and all those kind of other products that you've been coming out with. Madhu Ranganathan Yes. So we began to be product ready last October. And the aviator products themselves have come through a few evolution points. As I said, we're having hundreds of conversations. They are also translating into customers kicking off pilots and we noted Bosch as an important customer. We noted a large retailer that's thinking about a $50 billion of contract value in terms of AI. So the key thing here has been introduce what we call our Aviator Thrust offerings and grow our Aviator Thrust offerings. We have the sales team ready. We have the professional services team ready. So look to us to speak more about these pilots, to the use cases from an AI Aviator perspective, that will eventually turn into, I mean like turn into monetization. But more importantly, I think as you outlined earlier, we see the tailwind of this helping us in our cloud bookings. And that's really why we can see the 25% growth which again, if you do the math, it's well over $900 million of cloud bookings in the year, and we're actually quite excited about it. Steven Enders Yes. No, it's pretty impressive growth. I think you did -- you've talked about some of these early wins, but maybe we could talk a little bit more around the actual use cases that people are coming to OpenText to help solve for leveraging those AI. Like what do those look like? Or how do you feel like you're actually helping the customers leveraging your AI solutions? Madhu Ranganathan Yes. So a few comments there. The right to AI, we really think about it as the readiness for AI, as I talked about. We are just more than ready. For our customers, there's no vendor better than OpenText to deploy AI just given they have trusted us with their content and data, in many cases, multiple years or multiple decades. Customers are looking at optimizing like literally their $1 billion supply chain, right? And when you look at this volume of contracts where AI can be applied, you're talking about $50 billion worth of contracts where, again, the customers are deploying -- are thinking about pilots at the moment, but it's going to be what we call the steady, steady and somewhere an inflection point, right? And in the business network, for example, automotive, et cetera. They are looking at every single trade that can be optimized through that -- through the application of AI and Aviator. So whether it's a content customer or a BN customer, that's really where we personally are excited in the importance of how OpenText rolled out Aviator by the product group. We made it easier for the customer to not think too much about where the product would fit, but to think more about what problems and use cases that they're trying to solve, right? And stay tuned and more to come on that. Steven Enders I'm sure we'll hear more at the -- your conference in next month or... Madhu Ranganathan It's in November. I mean I was going to say, the product teams or sales teams are absolutely going to showcase all the product innovation and AI is going to be a key theme. It's in November 18 and 19, and you'll hear more from our IR teams. Steven Enders Okay. Perfect. No, I'm sure we're all excited and ready to see what comes out of that. Maybe shifting gears slightly, understanding the AI solutions. It sounds like it's having good performance on it. But maybe what does the macro backdrop look like today? Are customers at a point where the budgets are unlocking, they're beginning to put dollars to work for AI? Or what is kind of the general OpenText customers budget look like today? Madhu Ranganathan Yes. So I think one unique aspect about us is we don't speak about macro too often. And here are a few reasons for that. The macro is uneven for all customers. But for us, what we found is that a very positive macro background or a very challenging macro background, our customers are always sort of in the business of revenue augmentation or cost optimization. So our solutions become mission-critical from an enterprise perspective. And what I would also say is that the demand drivers we've talked about have remained very consistent for our customers. And whether it's private cloud, it's public cloud or SaaS, where they really look for is the value proposition in their environment, and that's really where our solutions are focused on. Our sales dialogues are kind of geared towards that. I would say, from a financial model perspective, we have assumed no improvement in interest rate environment and no improvement in the FX environment, which again, if there are green shoots on either side, we are certainly going to be able to do better. And the last one of the most important point, the breadth of our business model, the various product groups, we always find gives it an inherent resilience to macro, right? The business network could have macro impact from automotive or energy, oil and gas, but then content could be doing really well, right? So our growth rates are really predicated on sort of -- I mean, a combined influence of the macro. So we come out more resilient to the macro environment just given the nature of our solution as well as I would say, somewhat of a built-in resilience within the product groups as they're sort of the reaction to the macro. Steven Enders Okay. I guess maybe digging in a little bit more for the different segments. Maybe where are you seeing a little bit of strength right now, maybe things are a little bit softer. Any way to kind of help frame what that's looking like? Madhu Ranganathan Yes. So from a product group perspective, content to school again, our content is running very strong, right? And we see that runway quite far. And cybersecurity is a very important pillar for us and both on the enterprise side we called an SMB headwind. We're not quite calling it anymore. But as it turns into a tailwind, I think that certainly could be very supportive for us. But think about ITOM, and our solutions here certainly ServiceNow is the big gorilla out there, but we are in very exciting early stages of our service management solutions. So I think, Steve, many of our products are especially ones from Micro Focus, where we are relentlessly focused on getting those declines to flat to flat growth, right? So the product innovation, the go-to-market efforts inherent in all of that is going to be our own growth drivers, so to speak. Steven Enders Okay. Makes sense. On the Q4 performance, I think things maybe were a little bit choppier this quarter. Can you maybe kind of walk through what happened, I guess, what that looks like going forward? And I guess, kind of like what's fixable from that perspective? And how do you feel like the business is positioned to move forward here? Madhu Ranganathan Yes, absolutely. I'll take it from the last point of your question, the business is positioned very strong. Look, Q4 marks the last quarter of our fiscal '24, and we truly had an outstanding '24. Specific to Q4, the miss was on license, and the miss was on Micro Focus license. And what we found in the quarter was it was the same sales reps, account execs of Micro Focus who were speaking with the AMC customers about the divestiture that happened and how they're standing within OpenText still remain very strong. So if you really think about it, sales teams are all about selling time, lost a bit of selling time. We haven't lost the deals. We haven't lost the business and customers are well grounded, but that did contribute to a miss in license and Micro Focus license in Q4. Now Q4 turned the corner very nicely on our cloud organic growth. We were slightly over 3% in Q4. It was kind of the highest in the year. And we are assuming the trajectory into fiscal '25 at 2% to 5%. Again, we should measure the business and annual bookings growth rate. So the 33% is very strong, and I would point to the 25% in '25. So Steve, 25% is going to be marked by another second year built upon the strong scaled company with Micro Focus, the debt burden eased a bit with the delever of the $2 billion, right? And we can talk more about cash flows, but it's going to start the trajectory of growing cash flows. We are expanding EBITDA margins. So we look at fiscal '25 as it's a very strong foundation going into '26 and '27. Steven Enders Okay. I do want to ask about the kind of ramp here in the new medium-term guide that you laid out. I think before we get there, I guess you talked a bit about the selling time lost in Q4. I guess, as we think about the changes that got put in place here so far in 1Q and the RIF and some of the changes in go-to-market leadership. I guess do you feel like there's any kind of -- any incremental risk that kind of comes from those changes? Or how should we think about what that means for the business in 1Q? Madhu Ranganathan No, thank you for the question. And look no incremental risks and we believe only incremental benefits. Todd Cione has already hired quite a group of very strong sales leaders into various parts of the business. And we are very pleased with the hiring and as all of them ramp up is to bring the organic growth, selling DNA more and more into the business, right? We have to become more efficient given the scale and the restructuring we did, which is the first step towards that. We are investing a lot into our centers of excellence to actually get them even more productive and value-adding at a global scale and whether that's Canada or India or Romania and that's part of our plan. So I would say think transformative Micro Focus, divest of AMC, bringing OpenText along. We've kind of really stabilized and strengthened the company to what we need to deliver in '25 and beyond. Steven Enders Okay. All right. Makes -- that makes sense. Madhu Ranganathan And maybe if you don't mind, I'll just add. We talked about Paul Duggan, and particularly on the renewal side. Paul is launching, as he shared in the earnings call, I mean a digital renewal center, right? And renewal is $2.4 billion plus of business. And that's a very important step in turning the renewals from a renewal to expansion, and we can talk more about that if you'd like. But again, the changes we made, look, changes are hard, but we're very thoughtful about the changes we made, and these are absolutely going to strengthen us to grow, strengthen us to expand margins. and expanding margins is really going to put a better lens towards capitalization as well. Steven Enders Okay. No, that's great. Yes, maybe we do ask about the expansion and renewal potential of the business. And I think that historically, there's been focus on Micro Focus and trying to get that to kind of corporate average there. So how should we be thinking about what the implications are with the sales changes on retention rates and renewals moving forward? And how are you all thinking about the changes actually being put in place to drive that motion? Madhu Ranganathan Absolutely. Think of us a few steps behind what the industry has always spoken about like net renewal rates and expansion rates, right? So we are looking forward to bridging that gap. Look, the Micro Focus renewal journey was a great milestone in '24, but not quite done yet. We do want to get Micro Focus into the low 90s, right? So the net renewal rate has been in the works for a while, and it's obviously led by Paul Duggan. And we finished our renewal rates at 95% off-cloud, 92% cloud. If we had applied the expansion rate, they would actually be in the mid-90s, right, from a cloud perspective as well. Now all companies generally capture consumption and expansion. We captured consumption, we haven't captured expansion and which is what we look forward to bringing together to share. And that's where the real growth is the renewal reps in our business are not just responsible for renewing at a principal value they're responsible for adding workloads, right, adding premium rates. And we actually call it the customer success organization, and Paul has actually implemented new customer success tiers, which you will see in the expansion. And we believe '25 is the right time to do that. We're slightly behind, but we're looking forward to catching up. Steven Enders Okay. No, that makes complete sense. Maybe we can switch gears a little bit and talk a little bit about the margin profile here. I know there's been a lot of changes in the business. So maybe we can just talk -- just start on the short-term cash flow nuances or the interest expenses and kind of what the path to improving EBITDA and EBITDA conversion looks like from here? Madhu Ranganathan Yes, absolutely. So for fiscal '25, we're looking at 33% to 34%, right? EBITDA margin, adjusted EBITDA margin. Now when you actually look at fiscal '24, it was $2 billion of adjusted EBITDA dollars, that's 34%, right? Now the margin expansion from 33% to 34%, 36% in '26, and 36% to 38% is going to be contributed in a few different angles. From an OpEx perspective, we rightsized in early July through the plan you just mentioned. I talked about cloud gross margin. It's a very important lever to the EBITDA margin. A trough on cloud gross margin was 59%. We picked up in Q4. We are modeling low 60s in fiscal '25 and with some of the efficiencies and growth in revenue and scale and a better product mix of SaaS, which is also part of the engineering innovation. We do expect cloud gross margin to contribute. From an OpEx standpoint, we talked on the call about being more efficient in sales, having a AI Aviator to help out in our sales process and have engineering, have specific projects on automating QA all of that. So increasing those efficiencies actually going to get us to the 36% to 38% gross margin, of course, helped by the top line as well. Now that's going to translate to $1.2 billion to $1.3 billion in free cash flows, right? Our distribution of free cash flow our capital allocation is 50% dividend and buybacks. And at the moment, we believe our stock is the best buy. So we are actively in the share repurchase program we announced. And getting to $1.2 billion to $1.3 billion, expect the capital allocation on the remainder of the 50% will continue to decide between, as you rightly said, dividend, debt reduction share repurchases and selective M&A. Steven Enders Okay I do want to come back to that topic. But before talking about that, you have those fiscal '27 targets out there. And I think one of the questions we've still been getting, especially on the cash flow side is kind of help us bridge the gap between where things sit on the free cash flow today versus that '27 target. So can you maybe just kind of walk through the onetime things that are kind of in there and kind of bridge the gap between those 2 numbers? Madhu Ranganathan So the $575 million to $625 million we have for fiscal '25. It's a bit burdened by the tax gain in the AMC transaction and that's about $250 million. And again, we have to think about it as coming off of the proceeds, but it's going to hit the free cash flow this year. So if you were to take the midpoint and you sort of get up to more the $850 million range, that's really the path from the $850 million over to the $1.2 billion to $1.3 billion, right? And as EBITDA improves, our cash flow conversion from the EBITDA is also going to rise from somewhere in the 40s today into the upper 50s, and that's what's going to contribute to the free cash flow. Two important aspects here, including Micro Focus. Our working capital remains strong. right? Going from profitability to our operating cash flows, our working capital remains strong. We brought Micro Focus on to our working capital parity as you see from the DSOs and other metrics that we share. And notwithstanding the cloud growth, our CapEx also remains efficient, right? We've remained at around 2% -- 2% to 3% of revenues on CapEx and we're going to stay at that. And maybe a word on that is making our cloud operation more efficient is going to mean in the private cloud, our own data center footprint being more efficient and also leveraging the hyperscalers, right? So that's how we think about that, Steve. I think more in the $800 million range in terms of free cash flow as a starting point, if you want to talk about '25, '27. And then ramping up the EBITDA and then ramping up the conversion rates, but founded on strong working capital and CapEx efficiency. Steven Enders Okay. All right. All that makes sense. I do want to talk a little bit about the shift in the strategy a little bit in terms of how you're thinking about M&A. I think historically, think about OpenText. It's been a pretty big acquirer, and there was some digestion that happened here. And now it seems like instead of going full on the M&A bucket, it's more on kind of tuck-ins and some smaller things. So can you talk a little bit about how you're thinking about what that actually means from an M&A perspective to be part of the capital allocation plan. And what are kind of the criteria that you would be looking for in a potential target now? Madhu Ranganathan Yes. Yes, absolutely. Look, we are in a bit of a unique position that is not a very highly desired position, which is for all the things we've done and where we stand and what we have in terms of future product and growth and market opportunities, we do remain tremendously undervalued. So we prioritize share repurchases as top of the house from a capital allocation perspective. I think your term is right. I think it is about digestion. And for us, the digestion means getting the Micro Focus products back to more organic growth. Upping the renewal rates and clarification, we never did the Micro Focus transaction for their license business. We did it for the opportunities to cloudify and that was a 10-year journey for OpenText is probably a shorter journey as we look ahead. So that clarification of Micro Focus products is also part of the digestion process opportunity ahead, right? So all of those in front of us, we remain -- we believe our stock is -- I mean, our stock is the best buy. Look, we have a lot of muscle memory on M&A. That's an understatement, right? So we will be in the M&A market, but down the road as we get into a better currency from a stock perspective, improve the cash flows. And once again, we remain cognizant of the debt, so we'll keep evaluating the 4, which is, of course, dividend, repurchases, debt reduction and M&A. But when all of that currency improves and the right transaction comes in at the right value and the right value to us and the right value from a market perspective, we would not be hesitant to engage in it. Steven Enders Okay. I know we've kind of already touched on capital allocation a little bit. And like there is the view that the stock is cheap, so let's go buy it. But how are you thinking about -- well, you do have the plan already in place on that part. But how does that plan maybe come together? And how should we think about maybe what the right mix looks like moving forward between buybacks, dividends, M&A and also continuing to kind of delever the business? Madhu Ranganathan Yes. So as I said earlier, we haven't really modeled any improvement in interest rates, right? So the -- or sort of the average portfolio is still about 6%, and they still appetite to optimize that. So look, we have been a consistent dividend payer and look for that to continue, right? But between the other 3, we would definitely keep doing the math and the modeling around can we delever even more. We're delighted we delever 30%. Can we delever even more. Is the 2.9-ish the right net leverage ratio, could be lower than that. right, of course. And I think share repurchases as long as the stock is around these levels, we'll continue to prioritize share repurchases. The type of M&A we look at was also your question, our lens is definitely cloud-related M&A, right? And we can talk a lot about this, but we're not going to compromise on our cash flow targets, profitability targets, but grow your assets if they come at a reasonable price, and add to the organic growth of OpenText. And where we can bring our excellence in operations to those grow your assets and keep our customer target, we'll certainly entertain that. So I would say the measurement really is the value of the stock, is the cost of the debt, right? And how fast or how much can an asset add to our growth and add to our cash flows. Steven Enders That makes sense. You mentioned the leverage ratio. But I guess why is this kind of the right area, 3x, 2.9x. Why is that kind of the right area for OpenText to be at? Madhu Ranganathan So at a lower scale company being below 3 was sort of the right -- was sort of the right area zone for us. And at this point, I would say we are delighted with the 30% deleverage we did, but should the right opportunity present itself to delever even more, we will. And as you can appreciate, it's definitely a drain on the cash flows, right? And the more we can optimize the free cash flow, the opportunities open up as we just talked about in terms of M&A as well. So that's sort of how we think about the use of the cash flows. Steven Enders Okay. Right. Makes sense. I think we're running up on time here. We've got about a minute left. But I do want to ask about OpenText World in November, so I appreciate the clarity on that one. I guess, what should investors be paying attention to at the upcoming conference? Madhu Ranganathan Yes. So we welcome wide distribution of the content information, and we are looking for very strong attendance. We did something similar last year and Harry and the team did that. It was very well received. So here's what I'd leave you with, right? You hear a lot about the financial profile of OpenText and financial targets in our earnings call and plenty of conversations ensue on that. So at OpenText World, we're looking forward to presenting to you from the sales organization, from the product organization, and there will be plenty of real live product demos. So the 3 areas we'd like you to walk away with is much higher confidence around our product and innovation strategy, much higher confidence and several proof points of our growth strategy. And we're also going to add Shannon Bell, who leads our cloud operation to speak to you about cloud operations and infrastructure, which is important for the growth strategy. It is also important for the financial profile and cloud being kind of the lead growth driver in the future. So those would be the 3 big takeaways with plenty of other bells and whistles around it. Steven Enders Okay. All right. Well, that's great to hear. I guess we'll look forward to that event. Madhu, I want to thank you so much for being here and the rest of the OpenText team, and I want to thank everybody in the room as well. Madhu Ranganathan Yes, thank you, and thank you to Citi. Steven Enders All right. Thanks, Madhu.
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Earnings call: Wiley highlights strong Q1 with focus on AI and cost savings By Investing.com
Wiley (NYSE: JW.A), a global research and learning company, reported a robust start to fiscal year 2025 in its Q1 earnings call, led by President and CEO Matt Kissner. The company saw a 6% increase in adjusted revenue to $390 million and a 22% rise in adjusted EBITDA to $73 million. Wiley's performance was bolstered by growth in both its research and learning segments, with particular success in AI-driven content licensing projects. The company also achieved significant cost savings, completing its multi-year value creation plan ahead of schedule and closing all divestitures. Despite a lower Q2 revenue due to the timing of journal subscription receipts, Wiley remains confident in its fiscal 2025 outlook, emphasizing ongoing investments in enterprise modernization and a steady state goal of at least $200 million in cash flow in the long term. Wiley's strategic focus on AI and efficient execution of its value creation plan has positioned the company well for the fiscal year. As the company continues to modernize its technology infrastructure and optimize its cost structure, it aims to maintain a strong financial position and deliver value to its shareholders. With a steady state cash flow goal and a positive outlook on revenue growth, Wiley is steering towards a promising future in the evolving landscape of research and learning. Wiley (NYSE: JW.A) has demonstrated a robust financial performance as it kicks off fiscal year 2025, with a notable increase in revenue and EBITDA. Delving deeper into the company's financial health and market performance provides additional insights that could be valuable for investors and stakeholders. InvestingPro Data metrics reveal Wiley's market capitalization at approximately $2.39 billion, reflecting the company's size and market value. Despite facing some challenges, as indicated by a negative P/E ratio of -21.2 and a decline in revenue growth by -7.94% over the last twelve months as of Q1 2023, the company has shown resilience with a gross profit margin of 72.45%. This suggests Wiley's ability to maintain profitability on its core operations. From an investor's perspective, Wiley's commitment to shareholder returns is evident, with the company having raised its dividend for 25 consecutive years, a testament to its stable financial management and long-term strategy. This is further supported by a current dividend yield of 3.16%, which is attractive to income-focused investors. In terms of stock performance, InvestingPro Tips highlight Wiley's strong return over the last three months, with a price total return of 26.45%. This suggests a positive sentiment among investors, potentially buoyed by strategic initiatives and market confidence in the company's direction. However, it is important to note that the stock has taken a significant hit over the last week, with a price total return of -7.56%. This could indicate market volatility or investor reactions to recent events, which may warrant closer analysis. For those interested in further insights, there are additional InvestingPro Tips available, which could provide deeper analysis and help investors make informed decisions. Wiley's ability to navigate through market fluctuations while maintaining its dividend track record and showing signs of profitability this year could make it a company worth watching in the research and learning industry. Investors seeking to explore these metrics in more detail and uncover additional tips can find them at InvestingPro, with a current listing of 9 additional tips to consider. Operator: Good morning, and welcome to Wiley's Q1 Fiscal 2025 Earnings Call. As a reminder, this conference is being recorded. At this time, I'd like to introduce Wiley's Vice President of Investor Relations, Brian Campbell. Please go ahead. Brian Campbell: Thank you, and hello, everyone. I am with Matt Kissner, Wiley's President and CEO; Christina Van Tassell, Executive Vice President and CFO; and Jay Flynn, Executive Vice President and General Manager of Research & Learning. Note that our comments and responses reflect management's views as of today and will include forward-looking statements. Actual results may differ materially from those statements. The company does not undertake any obligation to update them to reflect subsequent events or circumstances. Also, Wiley provides non-GAAP measures as a supplement to evaluate underlying operating profitability and performance trends. These measures do not have standardized meanings prescribed by U.S. GAAP and therefore may not be comparable to similar measures used by other companies nor should they be viewed as alternatives to measures under GAAP. Unless otherwise noted, we will refer to non-GAAP metrics on the call and variances are on a year-over-year basis and will exclude held for sale assets and the impact of currency. Additional information is included in our filings with the SEC. A copy of this presentation and transcript will be available on our Investor Relations webpage at investors.wiley.com. I'll now turn the call over to Matt Kissner. Matt Kissner: Thank you Brian, and thank you everyone for joining us today. At the end of last fiscal year, I said that we were seeing strong momentum in our businesses and value creation activities, and that our culture had been reinvigorated by a much simpler and more efficient Wiley. I said then that we look forward with renewed confidence and optimism. I'm pleased to report that all of this is playing out in our solid performance indicators, colleague engagement scores, and in our financial results. As I said in June, we have more work to do to realize our full potential, and that work will continue. But the leadership team and I are pleased with our momentum and progress as we enter the new fiscal year. Our Wiley colleagues around the world have done a terrific job getting our businesses on a successful track. I can't thank them enough for their hard work and dedication and their unwavering commitment to serving our customers with excellence. In July, I was privileged to be named Wiley's CEO after serving in an interim capacity since October. I see no change in my approach. We will continue to be relentless in our execution as we publish more high value content to meet global demand, move decisively on AI growth opportunities, and drive operational improvements and rigor across the organization. I am grateful to our colleagues and stakeholders for their positive reception and support, and I want to thank the Wiley board of directors for their confidence and continued partnership. I'll start today with a quick reminder about our two businesses, review how we did against our objectives, and discuss our Q1 performance, notably the strong recovery and growth we're seeing in research. I'll also say a few words about how we're thinking about the IP licensing opportunity for GenAI training and development. Christina will walk through our segment performance, value creation activities and reinvestments outlook and financial position. Jay will then join us for questions. As a reminder, Wiley is enabling the creation of new knowledge and its application in critical areas of the global knowledge economy in science, medicine, technology and engineering, in business, economics, and finance. Our high quality knowledge, content and solutions remain as relevant as ever. Now that fiscal 2024 is behind us, I just want to briefly level set and remind everyone what we're focused on. Excluding our held for sale or sold segment, we're now organized into two operating segments, research and learning. The businesses complement one another with high value publishing and solutions in related markets and verticals. Our competitive advantage in both include our content libraries, brands, author relationships, category leadership, and reputation. In research, Wiley has one of the world's leading journal portfolios and the industry's most widely used content platform. Research publishing models include both read only subscriptions, read and publish hybrid licenses for institutions and corporations, and author funded open access where a peer reviewed article is made freely available for a publishing fee. Research solutions includes publishing and audience solutions for societies and corporations. The research segment has a large recurring revenue base that's 96% digital. Learning is academic publishing and courseware for higher Ed students, and professional publishing and assessments for professionals. Learning, which is particularly strong across stem and business categories, is seeing an accelerating shift to digital and institutional formats. As noted, learning content is increasingly valued for GenAI training models. Let's talk about the quarter. As expected, we're seeing a strong recovery in growth in research, driven by favorable demand trends and execution. I can't emphasize enough the great work our research team has done to get us back on track and delivering very solid results. Learning benefited from a second GenAI content rights project and delivered courseware growth in a seasonally light quarter. At the same time, the learning team continues to drive margin expansion reflected in strong adjusted EBITDA growth this quarter. We've essentially executed our full value creation plan ahead of schedule. Just last week, we closed our third and final divestiture and during the quarter actioned the remaining 40 million of the 130 million cost savings program. In June, we raised our dividend for the 31st consecutive year. Not many companies of any size can say something like that. We also increased share repurchases again this quarter. Finally, Wiley recently saw a marked elevation in our colleague engagement and satisfaction scores, which are critical to our ongoing success. I just got back from a trip to Asia, where I visited our offices in China and Japan. As with my earlier trip to India and Sri Lanka, I found our teams in Asia reenergized and highly motivated by the many improvements we've made. Our colleagues across the globe are all aligned and rowing in the same direction. Let's talk about how we delivered on our key objectives this quarter. First is to drive recovery and growth and research. We experienced an unprecedented year in fiscal 2024, but remain fully confident in a recovery. Given the essential nature of what we do, the enduring draw of our journal brands, and the momentum we saw exiting the year. I'm happy to say that our recovery is playing out as expected, if not better, both in our financial performance and leading indicators. Our second objective is to move decisively on near term AI opportunities. We executed a second content rights project with a large tech company this quarter, with 17 of the 21 million total value recognized in the quarter. Nearly all of it is in learning. We are seeing interest from other large tech companies and R&D centric corporates. Our third objective is to continue to drive performance and profit improvement through our value creation plan. As noted, we've closed all of our divestitures and actioned the 130 million cost savings program. Let me turn to our first quarter performance. Note, I'll be excluding our held for sale or sold assets in my commentary unless otherwise noted. As discussed, we're off to a good start with adjusted revenue up 6% to $390 million. Performance was driven by 3% growth in research and 14% growth in learning, notably the $17 million contribution from the content rights project. Excluding the large AI contribution, revenue rose 2%. Adjusted EBITDA rose 22% to $73 million, driven by revenue, performance and run rate cost savings. These savings were partially offset by investments in marketing and technology. Our adjusted EBITDA margin for the quarter was 18.6%, up from 16.3%. Adjusted EPS was up 74% due to higher adjusted operating income and accrued interest income from our divestitures. A few words about our GAAP performance. The GAAP revenue decline was largely impacted by foregone revenue from sold businesses. While the GAAP EPS loss was primarily due to a GAAP income tax adjustment related to our university services divestiture. Our adjusted effective tax rate is not impacted. Now on to our strong recovery in research. As a reminder, we saw our leading indicators rise significantly in the back half of fiscal 2024, giving us confidence heading into the first quarter. That's because the attributes that make this business great haven't changed. Research is tightly correlated with global R&D spend, which is ever increasing. Getting published is essential to a researcher's career, so demand is resilient. Wiley is one of the world's leading research publishers, with a very large catalog of high impact journals which form our competitive moat. And finally, the evolving open access publishing model allows more researchers around the world to publish and therefore expands our total addressable market. Our research team is making it happen. They're delivering better than expected numbers in submissions, output and open access growth. We've increased the top of the funnel by significantly enhancing our marketing capabilities, streamlining our sales efforts and increasing our editorial capacity. They've increased publishing output by investing in peer review and refer and transfer. They're focused on the right markets and investing in the right journal brands while continuing to optimize our journal portfolio. And we're just getting started. Here are some metrics to pay attention to. Global R&D spend is up around 8% since 2022, to an estimated $2.53 trillion. This number is expected to continue to grow at 4% to 6% annually over the long-term. Growth in R&D drives research submissions. Wiley is capitalizing on this trend. In Q1, submissions grew by 18%. We continue to operate more effectively and take advantage of favorable demand dynamics. Q1 output growth, which is a lagging indicator flowing from submissions, was up a very solid 6%. As noted, we've seen normal, healthy growth patterns return to the U.S., EMEA, and Japan, and strong demand continue in high growth markets like China and India. A year ago, we said that output would lag submissions by six to nine months, and it's playing out as expected. Our multi-year institutional models combining subscriptions and institutional open access grew nicely in the quarter, and Gold Open Access continues to grow at double digit rates. We continue to build on our position as a top ranked journal publisher, with 22% of our listed journals receiving an increased impact factor in the annual Journal Citation Reports. The reports are one of the most widely used sources of citation metrics to analyze the performance of peer reviewed journals. Wiley journals make up nearly 11% of all citations in the JCR index. Finally, our research end-to-end platform development is proceeding on plan and we expect to fully launch it by the beginning of fiscal year 2026. We're very excited about what this platform will enable to stand up new content offerings and improve article refer and transfer, reduce article turnaround times and cost per article, and detect research fraud through the use of AI. As always, there's more to be done, but a good start to the year for research and a confident outlook. I'd like to spend a few minutes discussing AI. As a reminder, our high quality content in science, learning and innovation is foundational for training large language models and building applications. AI developers and R&D intensive corporates can use it to improve accuracy, safety and impact. Demand therefore remains robust. This quarter, as previously discussed, we executed a $21 million licensing project with a large tech company for previously published content, our second such deal in consecutive quarters. 17 million of the 21 million was recorded in Q1, the remainder to be realized during the year. Nearly all of it is in learning, as LLM training demand is currently higher for book content than research journal content. The emerging demand for research content is more for LLM application development in specific disciplines and verticals. It's important to note that both of these projects involve backlist content, in most cases three years or older. The contracts are of limited duration, with limited rights and use, notably model training purposes. They are non-exclusive, subject to extension, and do not constrain us from pursuing further opportunities. These projects are incremental. They do not cannibalize our core. We see the content licensing opportunity in two stages. The first, as discussed, is participating in the near term development of foundational models. The second is in recurring licensing arrangements over the medium to long term as these models and applications come online and as information centric corporates bring our content into their AI environments. Let me say a few words about how we're approaching AI from a licensing perspective. First, content licensing is not a new or AI specific activity for us. It's really core to our mission and part of our day to day work to maximize the reach, readership, and revenue of our books and journals. We believe we have a responsibility to engage with AI developers. Our content is critical to ensuring scientific accuracy and impact and delivering optimal learning outcomes. Therefore, AI models should be trained on high quality, authoritative content like Wiley's. At the same time, we're being very selective about choosing when and how to partner with AI companies. We are careful to pick the right partners and to adhere to a strict set of principles around AI. The rights of authors and other copyright holders must be protected. Our job as a knowledge company is to ensure -- copyright holders should receive fair compensation for their intellectual property consistent with contractual arrangements. All in, we aim to be the most trusted partner to authors, societies and associations. They will continue to be our North Star as we assess and execute on opportunities in this ever changing digital landscape. All to say, Wiley remains highly valued and well positioned in the evolution of AI. I'll pass the call over to Christina. Christina Van Tassell: Thank you, Matt. I'm pleased to start by saying that we've largely executed on our multi-year value creation plan ahead of schedule. At this point, we've closed all divestitures in action, the $130 million run rate savings program, enabling us to reinvest while driving continued margin improvement. Just last week, we closed on our final divestiture cross knowledge. As we discussed previously, this is an immaterial transaction but frees up capital and with our previous divestitures allows us to focus on our core. This quarter, we actioned the remaining $40 million of the $130 million savings plan. The executed savings were largely in our corporate functions. Stepping back, we finished fiscal 2024 with $90 million actioned and $60 million realized in year. We've now actioned the full $130 million and anticipate realizing $120 million of that by the end of fiscal 2025 for an incremental in year savings benefit of $60 million. As noted, around half of that total run rate savings is being reinvested. Let's talk about where we're investing. We're focused on driving incremental growth in research, where we have clear competitive advantage and demand. This includes scaling our journal portfolio and article transfer capabilities, optimizing go to market to attract and retain authors, and extending our flagship journal brands into additional verticals. Second, we're investing in AI growth and productivity initiatives, including optimizing our content for large language model deployment, incorporating AI into our publishing platforms and workflows, and investing in productivity tools for our colleagues. Third, we're modernizing our systems to improve speed and productivity. We've talked about two specific areas, our research publishing platform and back office modernization. Let's turn to our research performance. Q1 revenue was up 3% due to strong demand and execution and research publishing. Research publishing delivered 4% top line growth driven by exceptional demand in gold, open access, and steady growth in our combined institutional multi-year models. As a reminder, our institutional models include both subscriptions for research libraries and institutional open access agreements with our library consortia. We expect to remain in this mixed model environment for a long time to come. We also continue to make good progress on our end to end research publishing platform, reducing our publishing turnaround time this quarter and enabling the submission growth we've been seeing. Research solutions was down modestly due to continued soft market conditions for recruiting, offsetting moderate growth in our publishing solutions business for societies. We're doing some very interesting things on the solutions side, but they'll take a little time to materialize. For example, we're expanding the reach for our medical education programs by nearly 3 million healthcare providers thanks to a new partnership. Wiley's medical education program allows healthcare professionals to do their jobs better, giving them access to information on the latest scientific outcomes, diseases and treatments. The end goal is to improve patient outcomes. Another important opportunity for us is inspector data. As a leading chemistry publisher, Wiley has one of the most comprehensive spectral database collections in the world. In Layperson's terms, Wiley's spectral database libraries allow end users to identify molecules and molecular compounds based on their unique chemical signature. Wiley has just released two new database collections using advanced AI techniques to significantly expand the number of compounds available for analysis, from food related compounds to industrial compounds. The end goal here is to help scientists reach better conclusions faster. In Q1 adjusted EBITDA for research rose 1%, driven by revenue performance offset by reinvestment in the growth and optimization initiatives I touched on earlier. Our Q1 margin was 29.3%, compared to 29.8% in the prior year period. In summary, we're confident in our continued growth and recovery and in the investments we're making to ensure our long-term success. Let's talk about learning. Revenue rose 14% in the quarter driven by the GenAI project and continued growth in academic, namely digital courseware. Excluding the GenAI project, revenue declined 1% in a seasonally small quarter, mainly due to softness in professional publishing and assessments. As Matt noted, our backlist content learning is in-demand for training GenAI models, and we'll continue to take advantage of this opportunity. We have two projects under our belt and continue to evaluate AI licensing opportunities that complement our business strategies. In the business itself, academics saw underlying growth again. Although Q1 is our smallest quarter for this business. Q2 is our largest and has only increased over time due to changing fall ordering patterns and shifting business models. Our STEM digital courseware product remains a consistent success story with top line growth above 30% again this quarter. We continue to see strong trends there in terms of winning new institutional agreements and expanding outward into new subject areas like data science. Institutions continue to gravitate towards inclusive access models where the cost of digital course content is added to a student's tuition and fees. This remains a nice tailwind for us. All to say, academic continues to benefit from favorable trends and sharp focus. Professional revenue rose 5% in the quarter but was down, including the GenAI project. The new authors and titles we signed up in the second half of last year will begin to benefit us later in this year, but then mostly in fiscal 2026. Finally, assessments was down modestly this quarter due to moderately reduced corporate spending on training and development. In Q1, adjusted EBITDA learning was up 60%, driven mainly by revenue performance. Our Q1 margin was 27.2% compared to 19.4% in the prior year period. In summary, learning remains on track with expectations. Let me turn from our segments to our corporate expenses. For the quarter, we saw a modest year-over-year increase, driven mainly by higher tech expenses related to our enterprise modernization, investment and expense growth driven by inflation moderately offsetting VCP savings. Important to note that corporate expenses here pertain to our unallocated expenses only. Enterprise costs are not specifically assigned to a business unit. Moving on to our full year outlook, we are reaffirming our guidance. We will have more visibility in Q2 as we make our way through the all-important fall semester in learning and the early part of the calendar 2025 library budget season and research. To refresh, we're projecting full year revenue of $1.65 billion to $1.69 billion for a top line growth rate of 2% to 4%. This is driven by an expectation of low to mid-single digit growth in research and low single digit growth in learning. The two AI projects already executed, one in Q4 and one in the first half of this year largely offset each other in year-on-year comparisons. Adjusted EBITDA is expected to be in a range of $385 million to $410 million for a growth of 4% to 11%. This reflects a margin target of 23% to 24%. Performance is expected to be driven by a combination of revenue growth and continued cost savings partially offset by investments in research, GenAI and enterprise modernization, as well as the impact of inflation on our expenses. Adjusted EPS is expected to be in a range of $3.25 to $3.60 for a growth of 17% to 29%. The primary drivers are higher expected adjusted operating income and accrued interest income from the divestitures, offsetting higher interest and tax expense. Free cash flow is anticipated to be approximately $125 million out from $114 million. This is due to improved working capital and lower restructuring payments, offsetting higher CapEx and higher incentive compensation payments compared to the prior year period. Note that annual cash incentive payouts are made in Q1 for prior year's performance. Over 90% of our colleagues are in the annual incentive plan. As noted, although CapEx in the first quarter is tracking behind prior year, we anticipated to ramp up in the remaining three quarters of the year. As a reminder, our full year CapEx projection is $130 million. Let's turn to our financial position. Free cash flow for the quarter was a use of $107 million in line with the prior year period. As a reminder, free cash flow is historically a use of cash in Q1 and Q2 due to the timing of annual journal subscription receipts which are concentrated in Q3 and Q4. Lower CapEx due to timing was offset by higher incentive compensation payments related to fiscal 2024 performance. We pay out our annual incentive compensation in Q1 of the following year. For the quarter, we allocated $32 million towards dividends and share repurchases, up from $29 million in the prior year. Over $12 million of that was used to acquire 295,000 shares at an average cost per share of $42.34. Our dividend payout is approximately 3%. Finally, net debt to EBITDA ratio was 2.0 at the end of July, compared to 1.9 in the prior year period. And with that, I'll pass it back to Matt. Matt Kissner: Thank you, Christina. Let me summarize the key takeaways. We're off to a good start, but we're not declaring victory. We have a lot more work to do to achieve our full potential. Still, I'm encouraged by demand trends and other performance indicators, our alignment and execution as an organization, and the material increase in colleague engagement. We've turned the corner on research, a business that has grown consistently over a very long period and remains an ever expanding opportunity. Our accelerating performance is not only market driven, but a collective outcome of many months of hard work and transformation by the team. We're publishing better, we're marketing better, we're investing in the right areas, and it's paying off. Separately we're moving decisively, but judiciously in responding to AI opportunities. We're reinvesting where we have a unique right to win, which will benefit us in the years ahead. We're off and running. We've largely executed our value creation plan ahead of schedule. Importantly, our culture today is far more energized, motivated and engaged. We can see that in our recent survey results. We're making decisions faster and moving with purpose. We're focused on less but doing more. We're empowering colleagues to make decisions and unlock pockets of growth. We continue to focus on rewarding you, our shareholders. I hope you can see our steadfast commitment to value creation and where we're focused, how we're executing and how we're allocating capital. And finally, we're confident in our fiscal 2025 outlook for revenue growth and margin expansion, and remain well on track to meet our fiscal 2026 targets. Again, what a difference he makes. I'll finish by thanking our Wiley colleagues for putting us in the position we're in. As I said before, nothing unites us more than being on a winning team. I'll now open the floor to any comments and questions. Operator: Thank you. [Operator Instructions] We'll take our first question from Daniel Moore at CJS Securities. Daniel Moore: Thank you. Good morning, Matt. Good morning, Christina. Thanks for taking questions. Daniel Moore: Start with, obviously, the momentum you were experiencing in terms of article submission. Maybe talk about that throughout the quarter in terms of cadence and so far into fiscal Q2 and how we should think about the potential organic growth and research revenue that may translate to over the next several quarters. Matt Kissner: Yes. Let me begin, and then I'll ask Jay to comment more specifically. But, this is a business with long lead times. As we've talked about in the past, there's a publication cycle that can, it can take six to nine months for an article to actually be published, and depending upon the type of article revenue recognized. So what's really encouraging is the, were the signals we started to see in the fourth quarter and have continued into the first quarter of a very healthy pipeline. I'll let Jay comment a little more specifically on what it looks like for the rest of the year. Jay Flynn: Sure, of course. Hey Dan, thanks for your question. So a couple of things to just reiterate, as we like to do when we talk about article submissions. The first is remembering that not all article submissions convert into published articles. There's a lot of variability in the mix. Right. We have higher acceptance rates from certain institutions, from certain authors, from certain geographies. So the mix of submissions determines long term article output. But as we've seen in our reported metrics this quarter and last quarter as well, we're seeing continued improvement, both top of the funnel and in terms of that translating into article volume output, we expect that to continue. We're pleased with the development of our submissions pipeline, as usual, but not all that volume will turn into published articles. And as we talked about both in our investor day and in our last call, not all those articles convert one to one into incremental revenue growth. A lot of that volume supports our underlying subscription business. A lot of that volume supports our transitional agreement. So, we're not going to say anything more about that, except to say that we're feeling good about the quarter and feeling good about the long term trajectory of both submissions and published articles. That's reflected in our guidance and that it's nice to see the research publishing business returning to 4% growth year-over-year. Matt Kissner: Yes, let me add, we're cautiously optimistic, let me say that about that, because it's such an important leading indicator. And I was in China, as I commented earlier last month, wanted to see what was going on the ground and just, there's some real strength there to see our people working aggressively on the ground to build this business. So we're, as they said, we have cautious optimism about this. Daniel Moore: Very helpful. And then shifting gears to AI, are you in discussions currently regarding any further similar licensing agreements to the first two? And can you just update us a little bit more secondarily on your progress in potentially monetizing AI tools to drive more recurring revenue, the second chance that you described? Matt Kissner: Yes, sure. And again, I'll begin and then ask Jay to get more specific, but we are seeing a lot of interest, as you might expect, in a market that's also rapidly changing. When we did our first AI deal late in fiscal year 2024, the market was even a little different then than it is now, but we are seeing a lot of interest because of the quality of our content. It's accurate, it's curated, it's indexed, it's perfect for training these models. At the same time, we're being very selective about the partnerships we want to pursue because we want to only pursue partnerships that meet our standards and are compatible with our strategic objectives. And Jay now has a team dedicated to this. And the benefit is one we're learning a lot and there will be future opportunities here as we work with these developing, AI model builders. Jay, do you want to get a little more specific for Dan? Jay Flynn: Happy to. I think first thing to say about this is, the quality of our content, the quality of our, of our output is very attractive to AI model builders. As Matt said, it's also attractive to research intensive corporations and the application development companies that are looking to supply tools to end markets. And so we're in discussions with a variety of potential partners. We're very selective about who we work with and we want to make sure that we adhere to our licensing principles. As we discussed in the presentation, in our prepared remarks, it's really important that Wiley continues to advocate for the rights of its authors with our society partners and, and our other stakeholders. The thing that I'm personally focused on and that the team that we've stood up over the last year has been focused on is really thinking about ways that Wiley can add recurring value and ongoing value to the research process, in particular in areas like drug discovery, life science, healthcare, chemistry, material science, those areas where Wiley is very strong and where there's a need for the latest information to be amplified by the power of these tools. And those opportunities present themselves to us and we're evaluating them. So we'll have more to say as they develop when we have additional news to report. Of course, we will do that. Daniel Moore: Helpful. Jay, Sorry, I was just jumping off mute there, switching gears. The disconnect at least, versus our estimates for this quarter in terms of maybe the share price this morning was on the expense side, I guess. First, how was the quarter relative to your internal expectations from a profitability and expense perspective? And then second, you've got obviously 60 million of incremental savings that you're marked for fiscal 2025, half of that reinvested. And yet overall, OpEx, not really seeing the benefit, at least in this quarter. Were there any unusual incentive comp or investment spend in fiscal Q1, and if not, maybe, why aren't we seeing, more of the benefit of that, those reduction initiatives, cost reduction initiatives on a net basis? Christina Van Tassell: Sure. I'll take that one. Dan. Hi. So from a revenue perspective, that wasn't, our revenue was in line with our expectations on the expense side. And what you're calling out is just a little bit of timing that we're seeing on a couple things. One is we do have, we do have some onetime items that manifest in Q1 that will normalize throughout the rest of the year, that's costing us a couple hundred basis points. Obviously, if you take GenAI out of that plus that, and then we've got, the investments that we're adding back that offset our VCP savings. If you, if you pull it all together and normalize, you're up about, you're up a couple hundred basis points on the quarter and for the rest of the year, we're seeing that normalize further. So we are seeing, we are, we are, as I said earlier, we are reaffirming our guidance and we are seeing a normalized rest of the year. It's just a little, it's a little bumpy in Q1 in terms of the puts and takes. Daniel Moore: And anything specific in terms of where those areas would be corporate, be it incentives, investments, for GenAI, etcetera. Any specificity you can give us there? Christina Van Tassell: Yes. So a couple things we don't give, but we don't get direct specificity on line items for competitive reasons, obviously on our investments. But we've talked to you about the characteristics of our investments. We've got growth investments within research. We also have obviously inflationary, I mentioned this in the prepared remarks, our inflationary cost increases that manifest in merit and other things in volume in production. And then the other investments, obviously this shows up in our corporate expenses. We've got the investments we're making in our enterprise modernization programs that will continue on for the next couple of years. Daniel Moore: Got it. And just to confirm if I have the numbers right, if they have $60 million cost savings benefit in yours that leave about $25 ish million for fiscal 2026 and beyond, just core, just total savings... Christina Van Tassell: Beyond fiscal 2025. Well, we'll continue to, we haven't called 27 yet in terms of what we're looking at, but we're continuing to look at the VCP, not just run rate, but what else we can start getting benefit from as things come online from our investments. So it's a little too early to talk about that, but it'll be certainly above that. Daniel Moore: Above that of what's announced. It's 10 million incremental. Okay, go ahead, please. Christina Van Tassell: Of what's announced is 10 million. So it's 120 this year, 130 next year run rate. Yes. Matt Kissner: Yes. Dan, it's important to note that we don't think we're done here. Yes, we're done with this program, but particularly with the investment we're making in modernizing our technology infrastructure. We see continued margin improvement. We haven't yet zeroed in on the numbers, but we're eager to continue to drive the kind of margin improvement trend that you're seeing in our current guidance. Christina Van Tassell: Yes, and we, as we said, we just announced our final divestiture. We're in, we're just finalizing some of our transition services agreements. Those will be done by, most of them done by the end of the calendar, certainly all of them done by the end of the fiscal and that gives us opportunity as well to continuously improve our cost structure. So we're looking, we're looking at that iteratively. Daniel Moore: Got it. And then I guess lastly, I've asked it before, but just leverage, around two times. But obviously cash flow is back end loaded, so should start to fall again as we look to the back half of the year. Just talk about your priorities for investing, excess cash flow at this stage. Thank you. Christina Van Tassell: Thank you. Yes, sure. So we're always looking at, obviously we have our, we're very proud of our dividend program. That's not going to change. We're always looking at our share repurchase program and as I mentioned earlier, we're 25% up versus Q1, but we're looking, we're constantly looking at that for the year. And last year, as a reminder, was up versus the year before. So we're looking at those opportunities as they come down. And we're also, obviously some other use of, we've got our CapEx that we're constantly know, looking at and that's a spend that is a $30 million increase over prior year. And they were always looking at opportunities in the marketplace. So that's where our capital allocation looks right now in terms of cash flow. And as I've talked about before, we are long-term looking to get back to our steady state of at least 200 million, longer term and beyond. Operator: And that concludes our Q&A session. I will now turn the conference back over to Mr. Kissner for closing remarks. Matt Kissner: Thank you all for participating. We look forward to another update in December and look forward to continuing to share our progress with all of you. Thanks very much. Operator: And this concludes today's conference call. Thank you for your participation. You may now disconnect.
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Corning Incorporated (GLW) Presents at Citi's 2024 Global TMT Conference Transcript
My name is Asiya Merchant. I cover the technology, hardware and tech supply chain here at Citi. Welcome to Day 2 of our Global TMT Conference. Very thrilled to have Ed Schlesinger. He's the CFO of Corning. We also have members of the Investor Relations team here in the audience. Of course, this session is for Citi clients only. I'm going to be turning it over. I have a set of prepared questions that I'll be going through. And of course, from the audience, we'll be asking if you have any questions, please do raise your hand. We'll bring the mic over to you. Let me turn it over to Ed. Ed Schlesinger Yeah. Actually, I just want to make a safe harbor statement before we start. I will be making some forward-looking statements today. You should review our filings on our website to see potential reasons that actual results may differ materially from the perspectives that I offer. So great to be here today and look forward to chatting with you all. All right. Ed, I have a bunch of prepared questions. Let's start with that. Corning is exposed to a variety of end markets here. Now we're sitting in calendar third quarter. Maybe as you think about how the market has evolved, versus your expectations, let's say a couple of quarters back. And as you think about it over the next six to nine months, what are you looking for? Ed Schlesinger Yeah. Maybe I will go back to the end of last year. We were in sort of what I would call a cyclical downturn essentially in all of our markets. We call the bottom of that downturn in macro for Corning as Q1. We said that would be our lowest quarter. And the cyclical downturn was both end market driven in terms of consumer demand as well as supply chain-driven inventory built up in various different parts of the supply chain. So as we went into the year, we expected Q1 to be the lower and then we expected markets to inflect up from that point. We didn't necessarily lay that out at the beginning of the year, but I would say there are markets that have recovered faster than we might have thought. Optical Communications is a good example. We saw a significant amount of growth in the second quarter, primarily driven by Gen AI, and that actually was ahead of what we would have expected as we started the year. And I think that will continue over the next 6 to 9 months, 12 months, we have pretty good visibility there. In Display, we expected panel maker utilization to inflect up. We were definitely at a very low point in the fourth quarter and first quarter. And that happened as well in the second quarter, a pretty strong second quarter, and that continues into the third quarter as well, and we've embedded all of that in our third quarter guidance. I would say in our other markets it's mixed. For example, heavy-duty diesel in our automotive market. We're actually now seeing a downturn in that part of the market. The good news is we're growing despite that, and we've again reflected that in our guidance. That maybe came a little more of an impact earlier than we might have expected as we started the year. And the good news is, again, that will be a cycle. And we'll get through that and that will kind of drive growth in later into the next several years. Asiya Merchant Great. Back in June, you introduced the Springboard plan. $3 billion incremental high confidence plan. You also have a $5 billion that you've kind of laid out that would not be risk-adjusted. So what was the driver behind introducing this plan? And there's a fairly big delta between the two. So the question I get from investors is what's kind of baked into that delta, if you can help explain that? Ed Schlesinger Yeah. So back in October, back of our third quarter earnings call, we started to talk about reaching the bottom and having an opportunity to add $3 billion of sales. The way we explained it was Q4 would be sort of a base, that quarter was $3.25 billion. So you annualize that roughly $13 billion. We'd have an opportunity to add $3 billion plus in sales over the next three years. And we started sharing that with investors, I think, partly because we were convicted. We felt really good about the opportunities we saw, but also we haven't provided long-term guidance in quite a while sort of through the pandemic in that post-pandemic period. And then we've been building out this framework over time. And in June, as you mentioned, we shared a view that went out five years an $8 billion opportunity, again, off of that base year run rate over a five year period of time. If you kind of clear that in a little bit to three years, a $5 billion opportunity with this $3 billion high confidence plan. The way to think about the five or the eight is that's our bottoms-up plan. So we rolled that up. We look at all the opportunities we have, we look at what we expect to happen in our markets, our innovation adoption, our ability to supply our customers, where we think we'll win and so on and that sort of frames out the five and the eight -- and where we have high confidence is around that three. We run a number of probabilistic models, and we sort of think about how investors should think about it. We think a three year time frame is a reasonable investment cycle, and we want to give you a high confidence view on how we think about things. Now a lot of things could happen that get us above that $3 billion. And if I think about where we are in Q2, cumulatively we're tracking at about $1.3 billion higher run rate from our base year. So we're actually well above sort of where we might have expected to be on that trajectory towards $3 billion. A lot of things -- a lot of milestones, a lot of things have to happen to get to that $5 billion, but our intention is to use this framework to sort of explain how we think about ourselves to investors as we go forward. Asiya Merchant And in that Springboard plan, I believe you also have new market access platforms. Just if you could double click on what those are and does that mean there is more capacity that needs to be if you were to go towards the newer market access platforms? Ed Schlesinger Yeah. So today, we serve five market access platforms, Display, Optical Communications, Mobile Consumer Electronics, Environmental, which is automotive and Life Sciences, and we're building out a new market access platform in the solar space. We're also -- we have an auto glass business that today is not part of our Environmental business. We'll move that business into that market access platform and we have a pharmaceutical packaging business and we'll move that into our Life Sciences market access platform. We'll kind of reconfigure all that as we go into 2025. So we'll share more about the solar opportunity over the next few quarters. We've got a bunch of work underway, and we'll share more about that with investors as we go forward. From a capacity perspective, as part of this Springboard plan, what we've said is that we have the capacity and technical capabilities. And you can think of that as cost like engineering, OpEx and so on to support the $3 billion plus in sales. And in my view, probably the $5 billion in sales. So our capacity or our CapEx expectations, which this year are to be around the level of our depreciation, I think includes the spending that we'll need even for that new map, certainly in this window of this three-year window of time. Asiya Merchant Okay. But you did talk a little bit about OpEx as well because that's a question that investors also have. So you're saying the OpEx is also rightsized too? Ed Schlesinger Yeah. I would say our current OpEx run rate as I think about Q2, Q3 is a pretty good level to think about. Our goal would be to expand our margins significantly as we continue to grow. We've been doing that. We're significantly above the trough from a gross margin perspective. We've improved our margins about 4 points despite still having some inflation embedded in there that we absorbed over the pandemic period. And actually, wage inflation, certainly embedded in both gross margin and in our OpEx. And we also want to leverage at the operating line in addition to leveraging gross margin. Second quarter is a good example. We expanded our gross margin from the first quarter by 1 point. We expanded our operating margin by 2 points. So our goal would be to grow sales at a faster rate, hold our OpEx at a relatively consistent level, and we should be able to expand our operating margin. Asiya Merchant Great. You talked a little bit about the company already tracking ahead of your 2Q -- at your 2Q level ahead of where you kind of think you want to be. How much visibility do you have that this momentum sustains itself? You talked a little bit about it, but just if you could clarify further, how much visibility do you have that you just kind of inch up from that $3 billion towards the $5 billion? Ed Schlesinger Yeah. I mean for sure, we'll continue to sort of provide a perspective on the three and the five as we go forward. I would say with respect to visibility, we feel really good about the next several quarters we guided Q3, we go up from Q2 and Q3. It won't be a straight line, and it won't be all at the same slope every single quarter. I think in the different markets we serve, I think we have pretty good visibility. In Optical, we have pretty good visibility going out several quarters. Again, next 6 to 12 months, I think we feel pretty good about continuing to be able to grow and accrete up to that level. And if we feel confident enough that we're above the three, we'll share that perspective. Asiya Merchant Right. Optical, given that I think about half that growth that you're talking about, the incrementals coming from Optical. You've indicated there that within Optical, the Enterprise portion of your business, which is roughly about a third, I think of your Optical is going to be about 25% CAGR. Can you help us understand, is that driven by AI? Is that just some normalization that's happening in that business as well? Is that just new data centers? If you can help us understand all that. Ed Schlesinger Yeah. So our Enterprise business, if you think about 2023 is about $1.3 billion. So just to give you the sort of magnitude of the size of that business. So we split our Optical business between Enterprise and Carriers, the remainder of that our Optical businesses in the Carrier space. We expect that enterprise business to grow 25% for the next three years. We actually put that target out in June. So a 25% CAGR from 2023 to 2027. So that would imply we more than double that business over that time period, just to sort of size out the opportunity embedded in the Enterprise space is the data center business, and we are seeing a significant amount of growth related to AI in the data center space. That will be the primary driver of that growth. I think there will be growth in other places. And the thing I would say is the Gen AI opportunity for us is a lot about data center operators building out a back-end network in addition to their front-end network to support their Gen AI opportunity to build their large language model to train those models. Those data centers, those back-end data centers require connection to the front end. They also house a much more powerful processing opportunities. So GPUs, the GPUs need to be connected to each other, not just rack to rack, but to GPU to GPU. So a significant amount more fiber, a significant amount more cable and connectors. We've invented new fibers, new cable, new connectors that allow that to happen in a smaller space with a lot more connectivity. And that's what's really providing the opportunity for us. And so we saw those new products start to ship in Q2 that was part of what drove our Q2 sales above the range that we had provided from a guidance perspective at the beginning of the quarter. Asiya Merchant Okay. And then maybe just this opportunity. Specifically what is Corning's competitive differentiation within this opportunity that you laid out regarding Gen AI and the new connectors that you've talked about? Ed Schlesinger Yeah. So we are the only end-to-end fiber, cable connectivity company in the world. We have the largest sort of U.S., outside of China based fiber manufacturing capability, we control the access to that fiber. That gives us an advantage to the competition. Additionally, we've invented new products, as I just mentioned, that put us ahead of where the competition is in this space and provide cost and efficiency benefits to customers as they build out their data centers, space becomes an issue. We've shrunk the size of the cables and the connectors significantly. And they have a lot more fibers and connections in that smaller space. So I think that gives us a huge advantage over our competition. It also creates a little bit of a moat around our business. And we have long-standing relationships with a lot of the large players in this space, but there also are a lot of new players in the space. And we're continuing to win business in that respect as well. So I feel pretty good about our ability to do well in this space. Unidentified Analyst Do you have a sense of your market share in that space? Ed Schlesinger Yeah. We don't disclose that information. But yes, we are a dominant player in the space, but we don't disclose that information. Maybe just to frame it, like in your regular fiber business, what do you have like 40% market share globally or something? On this topic, can you talk a bit about the greenfield infrastructure? Asiya Merchant That was good. Next question. Actually, pretty lien into, just talk about the Carrier side of the business because I think the Lumen is kind of -- is it in between Carrier and Enterprise. You talked a little bit about it on your earnings call. So maybe for those who may not be familiar with what's going on with Lumen, you could outline that? Ed Schlesinger So the way to think about it is enterprise is inside the data center for us -- and then typically, we sell to carriers, carriers have their plants. They have outside plant and they do fiber-to-the-home and other applications, 5G et cetera. The Lumen deal actually is data center interconnect. So it is for data centers, Gen AI data centers in particular, but it's actually outside the data center. I see that as a new market opportunity perhaps for us beyond even the Lumen deal, and I can talk a little bit about the Lumen deal. We have not included that. So in the $1.3 billion business I talked about and the CAGR I gave, the Lumen deal is not included in that. We're not thinking about that right now as sort of being inside the data center or inside our Enterprise business. But it is related to Gen AI, and I understand that people really want to track that. So we will give that some thought and think about how we can provide more of a Gen AI perspective on how that impacts our business in totality, including things that might be data center interconnect, which would be outside the data center. And I'm sure you've all read the Lumen deal. I won't talk so much about their deal, but they actually have a significant opportunity to connect large data centers or hyperscalers across the United States because the data centers will require so much processing power that they will connect them together to create these large networks. We're going to provide Lumen with the cabling to be able to do that. We've also invented a new cable that actually doubles to quadruples the opportunity for them to fit fibers in their existing conduit. So they have an existing network of conduit that connects long haul or city to city opportunity. And we will allow them to sort of retrofit, if you will, their existing conduit with a much smaller cable that allows a lot more bandwidth in there. So that's what the opportunity is. They've reserved about 10% of our fiber capacity. So you can sort of think about that as roughly 10% of our sales in terms of the size of the opportunity, it's a multiyear opportunity. So it's incremental to the way we were thinking about our enterprise business. It's many of the reasons why we feel confident about the next several quarters. Asiya Merchant So sorry, so the Lumen deal, I know it's not factored into your third quarter outlook as well. I guess because the revenue opportunity is unlikely to materialize in third quarter, and it's going to start more in calendar '25, is that correct? Ed Schlesinger Yeah. It's possible we ship a little in the fourth quarter, but I think you should think of it as 2025, 2026, 2027 versus 2024. Asiya Merchant Right. And it's built into your high confidence Springboard plan? Ed Schlesinger Yeah. So we get this question a lot. And maybe the way I'm going to answer it is in the $5 billion opportunity I think it's included in that. When we think about how big Optical could be, and it's a significant portion of that $5 billion, you should think of it in there. In the $3 billion, we're really not being that specific. We're sort of running a bunch of different scenarios and probabilities on how we think we have the ability to provide you with a high confidence view to make investment decisions. At some point in time, we may be running well ahead of that, and we will share that view. So -- when I think about the $3 billion, we're not really thinking about exactly how much of that comes from Optical versus Display versus Life Sciences, et cetera. We have a view of that in the $5 billion plan, but not so much in the $3 billion. Asiya Merchant Alright. Outside of Lumen deal, maybe if you can just talk about the rest of the Carrier side of the business. What's going on there? Is there some sort of mean reversion to the kind of chart that you share in your earnings deck? Ed Schlesinger Yeah. So at the onset, I mentioned we were sort of in the cyclical downturn. Carriers were part of that as we sort of exited 2023, supply chain inventory driving a lot of that. They were buying less than they were deploying, depleting inventory that they had built up. We've seen that start to dissipate I would say we're mostly through that, but certainly not completely through that. So our sales have gone up in the carrier space as we progress through the year, probably at a slower pace than we might have thought at the beginning of the year, but we are seeing that inflect up, and we expect to continue to see that inflect. Additionally, BEAD, which will start to kick in, in 2025 also probably happening a little slower than we would have thought maybe a couple of years ago when the plan was put in place is beginning to gain momentum. And we expect that to drive additional deployments as we go into 2025, which will drive Carrier growth '25- '26 and beyond that time window. So carrier is definitely moving in the right direction, positive, but certainly not driving as much growth as we might have expected in the short-term window here. So I think the good news is that's an opportunity in the future to fill out Optical in that $5 billion space. Asiya Merchant Okay. Do the U.S. elections have any impact on the BEAD or the outcome of the U.S. elections have any impact to the BEAD funding? Ed Schlesinger I don't think so, although the reason I would say no is because it benefits every state, red state, blue states benefit, a lot of the states that are currently filing for funding in BEAD and winning those funds and actually starting to deploy our states that would be Republican state. So I don't think it has an impact. Asiya Merchant I'm going to switch it to some of your other businesses, Display. I get a lot of questions on that. It's obviously a big profitable side of your business. The net income margins there are higher than your other businesses. You did talk in your last earnings call about pricing negotiations going on with those. Obviously, investors want to know what's going on there. And just your ability to pass through price increases just given the TV demand outlook? Ed Schlesinger Yeah. So just to rehash maybe where we are, what we shared back, I think it was back in May is -- we're in the process of implementing a currency-based price adjustment across our customer base, hedge the end. We have hedges in place for 2025 and beyond. Our hedges are not at our current core rate of 107, but they're much better than the spot rate. Spot rate has been coming down, but our hedges are better than the current spot rate. And our goal is to -- in combination with our price adjustments and our hedges, maintain our level of profitability in the display business. And you can think of that as the average over the last several years, maybe last five years, net income percent of sales in Display. So that's our objective. And when I think about the Display business, we're the technology leader, we're the cost leader, we're the market leader. We expect to maintain our cost position. So that sort of takes care of price, that takes care of cost. So what's left is really volume. And I think about volume as being driven by screen size. We're not expecting unit growth necessarily in display, units have been relatively flat over the last several years, but we are expecting the average screen size to go up. It goes up and into several year, that adds a few points of growth of glass into the market. So we expect Display volume to grow over this next several year time period, we expect to maintain our profitability through these price adjustments and to maintain our strong cost position. Asiya Merchant Within that Springboard plan, what's the contribution of Display? I think I do see a little sliver line that's attributed to Display. So are you expecting off the base level that Display revenues, not just profitability growth? Ed Schlesinger Yeah. I think the way to think about Display is you go back to that Q4 2023 base, right? And from a run rate perspective, I do think Display could increase if volume increases over that time period, we could see revenue growth from that. But I think the most important thing is our ability to maintain our profitability, which then allows all the other growth that we get in this plan to live through. And so if we're successful, and we'll share an update on the pricing with investors when we are sort of through the process, if we're successful with all that, I think that actually underpins a lot of the growth that we'll see in other places. Asiya Merchant Okay. And just near term, there's a lot of -- just with third quarter and even into 4Q, I think panel makers talking about bringing down some utilization to just kind of manage inventory levels? Just any updated thoughts on that? Ed Schlesinger Yeah. I think if I start with the market, it's pretty flattish. I think units will be pretty flat. I do think there'll be a little bit of growth overall, and I'm thinking year-over-year, '24 versus 2023, that will be driven by average screen size going up to some extent. Panel Maker utilization tends to be a little higher in the second and third quarter, maybe the fourth quarter. So you can't really I think about it quarter-to-quarter, you sort of have to think about it on an annualized basis year-over-year. And I think what we're seeing so far this year and into the third quarter is about what we expected. And I think it's keeps the market in a pretty good place relative to the expected demand. Asiya Merchant All right. Switching out to the audience, any questions before we jump into some of the other segments. Questions. Okay. You talked a little bit about that. It's in your Environmental side of the business. And plus you have the auto glass, which is part of your Springboard, which is incremental. So just first talking about what's already in the Springboard and then -- sorry, what's already in the baseline and then the incremental that you're talking about earlier? Ed Schlesinger Yeah. So in the auto space, we have our legacy Environmental business, which is filters and substrates that business will continue to perform well. We're seeing a small downturn in heavy-duty. So that's impacted us here in the short term. The opportunity in that space is the U.S. has implemented new rules, the EPA has implemented new rules, which require gas particulate filters on automobiles starting in 2027. We should start to see sales in 2026 as the '27 model years get built out. So that should drive growth in that business towards the end of the three-year window, but then beyond that window. In auto glass, we have a triple-digit sized auto glass business. I'll explain it a little bit in a second. And we expect that business to triple over this window of time, so from the beginning of '24 through the end of 2026. So a nice amount of growth coming in that auto glass space. We serve the inside of the vehicle displays, think of large form factor displays and other glass inside the car. That's the interior glass is the primary revenue driver today and will be the primary growth driver over the next few years. We also do exterior glass for the outside of the vehicle and then specialty glass for applications like LiDAR or other autonomous driving applications. Those opportunities, I think, will come as well, probably later in the time cycle and maybe beyond what this three-year window of time. Asiya Merchant Okay. And so I know in the past, Corning has talked about your current content, including GPFs being around maybe 40%-45% and then getting up to $100 of content per vehicle that includes perhaps this auto glass? And does it include LiDAR and all these exterior opportunities as well? Ed Schlesinger Yeah. The $100 per car opportunity includes the environmental business, GPFs. It also includes the interior vehicles, the exterior vehicles and LiDAR. So that -- we see that as the sort of addressable opportunity for us. We've been accreting up. We have a very strong position in the environmental space, and we're building out a business in the auto glass space. And I think the nice thing about the auto glass space is it's not really driven by the market, it's driven by the adoption of technology, right? We don't need more vehicles. It doesn't necessarily matter whether they're BV or their ICE vehicles. It's just the technology adoption, displays, autonomous driving and connectivity that drive the need for our products into the vehicle. So I think that will be the big driver of how we go from where we are to that $100 opportunity. Asiya Merchant And just given the greater content growth, there is obviously chatter about auto still being weak. Just how you think about -- I know you're talking about more of a three-year time frame, '23 to '26, just given the dynamics that we're seeing right now in auto has been perhaps a little bit weaker as an end market. Is there any difference between geos adopt the interior auto glass or any particular drivetrains that are more likely to adopt the interior auto glass? Ed Schlesinger I would say, more autos is good. No, just in general, more cars is good. But I think it's mostly about the changing the way the cars drive, autonomy is the best example. I think as cars become more autonomous, the need for products that help control the car, things of that nature are really what's going to drive the technology adoption. Large interior displays, you see that more and more in vehicles, even certainly in high-end vehicles, but you're now starting to see that in vehicles sort of all the way through the value chain. I think that's really the driver. So the market being weak, I don't think has an impact on our ability to grow in that space. Asiya Merchant And just your competitive positioning here, anything that you can share about how you guys are versus some of your other peers or competitors in this space? Is there a lot of competition in the auto glass space? Ed Schlesinger Yeah, there's certainly competition. We have a ColdForm technology, which allows us to make these large form factors at a much lower cost. So that gives us a technological advantage on an interior display. So if there's form required, if there's size required that actually is a competitive advantage for us. Asiya Merchant Okay. Maybe just switching to mobile consumer electronics. That's another one within the specialty semi. Maybe if you could talk about what's going on there? It's a business that's fairly cyclical. You have new form factors that come through and you see a big step-up in your specialty semi sales. It's a fairly profitable part of your business. So what's going to be the next driver there? Ed Schlesinger Yeah. Maybe starting with the markets, we serve sort of two markets -- I mean, more than two, but primarily two. We have an Advanced Optics business, which is primarily directed at the semiconductor space. And we have a Gorilla business, which is directed at mobile consumer electronic devices like phones, smartphones, tablets, PCs, et cetera. On the Gorilla side, the markets have been relatively muted units. There's not much unit growth. We're not expecting much unit growth this year. We've grown that business significantly faster than the market over the last decade because we've added content, so dollars per phone has gone up significantly as an example. We'll continue to do that. We're not expecting any new significant innovation adoption in 2024, but we do have some things that I'll kick in a little bit later in our Springboard plan, new form factors, bendable glass think of foldable in that space. On the semiconductor side, we have actually been growing that business quite nicely. We primarily serve the semiconductor equipment manufacturers with specialty glass. And we expect that to continue to grow over time as that market continues to grow. So 2024, I would say we haven't seen a lot in our Springboard plan, but there's an opportunity in '25-'26 and beyond that for mobile consumer electronics to contribute more than it is contributing today. On the -- in the fiber business, especially in these innovative new fiber, whether it be the stuff for Lumen that's smaller and more and also the back-end fiber inside the Enterprise data centers. Is it fair to assume that, that's significantly better gross margin because of all the innovation you're bringing to the table? Ed Schlesinger Yeah. I think to the extent we can provide an end-to-end solution. The way to think about it is we make fiber, we sell fiber, we make cables, and sell cables. We make solutions or connectors. Those solutions are generally a higher margin opportunity for us than if we're selling sort of base fiber or base cable. So you should think about it that as we grow that business, our margin should improve. Just with respect to the $5 billion target, I guess, like the $3 billion target in between, right? Can you give us a sense of how much of that is going to come from BEAD and how much of that is going to come from Gen AI? Ed Schlesinger So far, Gen AI contributed a fair amount, and we expect it to continue to do that in the foreseeable future. BEAD will kick in, in 2025. I would be cautious to provide specificity because it's taken longer for BEAD to sort of deploy. I think there is a huge opportunity for us, hundreds of millions of dollars of incremental sales that come from BEAD exactly when that starts and kicks in, it's hard to call. So it may go beyond this three year window of time, and it may come faster depending on how sort of the states and their particular carriers wind up doing their deployments. Unidentified Analyst For the inside the data center fiber, do you sell that directly to like the cloud service providers? Or do you sell it to like equipment OEMs? Ed Schlesinger Yeah. Our customers are the hyperscalers themselves, yeah. Unidentified Analyst Is there a way to think about the relative size of the Optical opportunity within the data center versus between data centers? Ed Schlesinger There probably is a good answer to that question, but I'm going to -- I'll tell you what we will -- I will think about that, and we'll come back to you on that one, if that's okay. Yeah, I think it's probably a little early for us to size the data center interconnect opportunity, but we'll come back and answer that question. Asiya Merchant Okay. Maybe we can talk about capital allocation, Ed. I know investors have been asking about capital allocation. It's been a while since you've had your Investor Day. How should we think about -- you started to buy back shares, I think, in calendar 2Q. Just how do we think about the fact that you're kind of holding CapEx relatively flattish? You're going to be generating free cash flow with sales growth. How should we think about capital allocation? Ed Schlesinger Yeah. So our capital allocation approach starts with investing for organic growth. We're an organic grower. That's how we see ourselves. We think that creates the most value for shareholders over the long term. The good news, as you mentioned, is we have capacity in place, so we don't need to make significant capital investments. We also have the technical capabilities, so the other costs in place. So we don't have to make significant investments there, which should mean as we grow, we generate more cash flow. I think that's good. Second, it's important for us to maintain a strong balance sheet. We like having an investment-grade balance sheet. We invest over long cycles of time. So we never want to have a time period where we can't make investments. And again, I think the good news here is we have a strong balance sheet. We are investment grade. So we don't have to do a lot of work on our balance sheet. So that leaves deploying capital to shareholders. We pay a very nice dividend. We'll continue to pay that dividend, and we started buying back shares in the second quarter. We've continued to do that in the third quarter. And our plan will be as we're successful on Springboard, we'll continue to accelerate that. We have not articulated any specificity on exactly what we're going to do. But certainly, we intend to continue to buy back shares. Asiya Merchant At the Market Access platform, the new market access platform, you talked a little bit about the solar. Can you expand on that a little bit? I know you have Hemlock. How should we think about -- are you planning to grow that business? What are some of the drivers for growth and profitability in that business? Ed Schlesinger Yeah. We plan to come back in the next few quarters and share a little bit more about this map. We have a few other milestones and things we want to get done and we'll then kind of talk a little bit more about it. We think it's a nice opportunity for investors. It's a nice opportunity for us and investors. There's a lot of incentives in the IRA and in the CHIPS Act that we are using to help build out the business. So we'll share a little bit more about that over the next several quarters. Asiya Merchant All right. And I know investors do still ask about yen. I know you talked a little bit about that. When should we expect an update on what the new yen rate is? Ed Schlesinger Yeah. So we're in the midst of doing our Display price increase. We have hedges in place, as I mentioned, they're not in our current core rate, but they're certainly better than the spot rate. When we're done with the Display price increase, we'll provide an update certainly before we get to 2025 on how we think about both Display price and yen. Asiya Merchant We have a couple more minutes. Any other questions from the audience? Ed, if you were to step back and kind of think about your market share positioning in each of your core markets, -- how should we think about that? I'm sorry, is there a question there. I'm sorry, I didn't see your hand raised. Okay. Unidentified Analyst Can you just talk about whether or not the Supreme Court ruling on the Chevron doctrine [ph] or whatever it's called effects. The -- you mentioned, for example, the EPA putting in the new regulations regarding the filters and the technology content in autos, do you expect pushback from automotive? Manufacturers and other customers on those kinds of regulatory interventions that increase the technology content in cars and other applications of your products? Just about your market share positioning across some of your end markets or technology offerings. If you step back and think about it, Display, I think you guys have said you feel comfortable you're not exceeding share despite the price increases. Just I guess there were some questions on Optical as well. Can you just step back and think about how you're thinking about your market share positioning across some of your core technology offerings? Ed Schlesinger Yeah. I think the best way to think about us is that our goal is to be the market leader, the technology leader and the lowest cost producer in the markets we serve. And that is generally the case across most of the markets where we compete. So we work hard to achieve all three of those things. I don't see anything today that is deteriorating us in any particular space. And we'll continue to obviously work hard to improve market positions as we continue to grow. Asiya Merchant All right. Thank you. That about wraps it. Thanks a lot, Ed.
[5]
Digital Realty Trust, Inc. (DLR) Citi's 2024 Global TMT Conference (Transcript)
This session is for Citi clients only, and disclosures are available in the back of the room next to the AV desk, and we also have them conveniently up here. If you'd like to scroll this electronic copy on the iPad, feel free at any time. And with those housekeeping items out of the way, for those of you I haven't met, I'm Mike Rollins with Citi Research, and we're pleased to welcome Matt Mercier, CFO of Digital Realty. For everyone in the room, we may do some live surveys during our session. So there's QR codes up here. And there, you just scan them and you'd be able to participate in our live surveys. They're anonymous. We're not tracking the results. So look forward to your participation for that. So Matt, to get started. It's been a busy year for Digital Realty. And I think back over the past year and all the things that you've progressed with in terms of the business, I'm curious if you could help frame the go forward strategy on how Digital Realty is positioning itself to grow revenue, profits and improved return on capital? Matthew Mercier Sure. So as you know, Mike, we've gone through a bit of a journey over the last 12 months to 18 months, really with the objective of putting the balance sheet back in better shape, which we've largely accomplished. Bringing leverage down from what was kind of height of around 7 times, we're now down to 5.3 times, so really put us back into a position where we can be back a little bit more on what you'd say on offense, $4 billion of liquidity. And really, I think, puts us in the position now to be able to take advantage of what is a very robust demand environment, being able to leverage the broad global platform that we have available, our capabilities across that from both satisfying greater than a megawatt type requirements, which are getting obviously a lot of the headlines today from AI, but also being driven by more traditional workloads like cloud and digital transformation that are also growing at a nice clip. That demand in what has been an environment of more restricted or constrained supply has also led us into positive pricing environment, which accrues to us not only in our existing operating portfolio through better mark-to-markets and better same-store stabilized growth, which we've experienced after a few years of negative results, now being in positive territory over the last two years, and is accruing to us in terms of our development pipeline, which is solidly north of 10% on average across the, call it, 430-plus megawatts that we have under development today. So all that being said has now I think put us in a position where we've talked about, even as we started 2024, as we were giving '24 guidance, we were, in essence, already giving '25 outlook at the same time, which we don't typically do. But we've talked about in terms of setting sort of a baseline for '25 growth at 5% as we get the benefits from all the things we just talked about, flowing through to not only the top line, but the bottom line from our organic portfolio, but also as those development deliveries come into operation from some of the significant signings that we've accomplished, not only this year, but into last year, which I'm sure we'll talk a little bit more about. But really sets us up for what is baseline 5% growth in '25, and I think looking out, accelerating beyond that in '26 and beyond. Michael Rollins And so when you think about the outlook that you mentioned for '25, the 5% growth, are there even some headwinds that you're experiencing, whether it's continuing to average up that interest cost or delays between some of the recycling and when the commencements take place for the reinvestment of the development, where the underlying organic growth may be different and better than that 5% for '25 over the longer term? Matthew Mercier So I would say in terms of what I call on the capital recycling front, we should be -- we did the most of that work, Greg and his team on the investment side, and really across the company, a tremendous amount of work done in starting sort of the back half of '23 into the first half of '24 in doing the capital recycling, informing some of the development joint ventures that we did with Blackstone, which is really part of being able to satisfy what is a large and growing set of requirements and demand across our hyperscale universe. So I think the impact from that effort, which is also getting us in place in terms of bringing the balance sheet back into good standing, better standing, the majority of that impact I think we're seeing now in '24. So that should not -- that should have less of an impact on '25. What I think sets us up for sort of improving growth in '25 and beyond is more as you start to look at from an organic perspective, as you look at our lease rates, from our expiring lease rates, you start to see that. The comps and the rates continue to get lower over the future years, right? And given an expectation that pricing is going to remain where it is, if not improve, that's going to give us I think a better opportunity for improved mark-to-market and better same-store growth in '26 and beyond. On top of that, I think we're starting to see some of those higher development deals and projects deliver in '25. You could look at the considerable backlog we have currently. That's going to start to hit in '24, but there's going to be a decent amount that's 25, back half of '25 and beyond as it takes time for us to build and deliver those projects. So I think -- and at yields that we've seen that have been improving. So those two factors are going to, I think, be more of the catalyst for improved growth in '26 and beyond. Michael Rollins And you mentioned the capital recycling program. Is that based -- you mentioned you're kind of through a lot of it. So going forward, where in the last few years, had a significant amount of capital brought back to the company to reinvest from noncore assets, converting some hyperscale into JVs. Is there a significant amount of that in the future you can use for funding or you're kind of now at the steady-state asset base that you want to be at? Matthew Mercier I think we've talked about it in terms of like, sort of step one was diversifying our sources of capital. And I think we've done a lot of that through a lot of the activity that we just talked about through that happened in '23 and has continued in the first half of '24. I think we see that there'll still be a need for having a broad and diverse source of capital. So we talk about it more in terms of evolving our sources of capital. I think we'll see us continue to look for the right capital partners and the right structure that helps us not only be able to fund and take advantage of what is probably one of the most robust and strong demand environments that I've seen in quite some time, but also make sure that we're continuing to focus on what is objective 1, 2, 3, which is back to making sure that we're growing the bottom line in '25 and putting this in a position to be able to improve that growth in '26 and beyond. So it's really putting together that right mix of delivering for our shareholders but also being able to take advantage of this market, utilize outside capital for some of these larger developments so that we're not also overexposed to hyperscale, which has been bread and butter for us for many years, but finding that right mix that gives -- continues to put us in a position to be able to win, not every deal, but I think the right deals in the right markets where we can provide a better value proposition and again, focus on that bottom line growth. Michael Rollins So one of the interesting, I think, features of Digital Realty is you offer data center colocation across the broad spectrum of size and connectivity. So as you continue to operate and evolve the current strategy, how do you look at the success of keeping all these assets together under a single roof and whether this is the optimal strategy going forward for Digital Realty? Matthew Mercier Yeah. I think it's been an important part of our strategy to be able to really satisfy that broad product spectrum, as you talked about. So our heritage, the DLR heritage has really came from more of that, call it, greater than a megawatt, it's been called different things over the years, but called that scale, hyperscale, greater than a megawatt segment, right? That's been part of our company and our history, having those relationships with those large technology and large enterprise customers. And we've seen that as its evolved through from digital transformation to cloud, now to AI, and that customer base has been driving a lot of the activity there. At the same time, we've also seen the benefits of, call it, the retail colocation and broader enterprise story in terms of the stability, the stickiness, driving interconnection and really having that as a solid foundation to our overall platform and our overall strategy. And you get customers that span between those two as well. So some of those larger customers are also taking smaller network-oriented workloads and nodes within our portfolio. And I think we see an advantage over time and again, not only sticking to our core markets, which is also part of our strategy and not extending ourselves too far beyond where we have these campuses that can, I think, ideally and optimally bring together both the workloads from scale, hyperscale type customers, but also being able to utilize the connections that we have to the enterprises and to the networks from our 0 megawatt to 1 megawatt and interconnection business. Michael Rollins So you're seeing a magnetic effect between these two bring more parties to your campuses? Matthew Mercier Yeah. I think there's obviously uniqueness between each of those segments, but there's also -- in the Venn diagram, there's also a powerful connection that I think we see over the long term, puts us in the best position to be able to satisfy the workloads of not only the hyperscalers in our core markets, but also to be able to add on the benefits of networking and other interconnection capabilities within the enterprise segment and really puts us, I think, in the right position to be able to generate stable long-term growth to the bottom line. Michael Rollins You mentioned the strong demand environment. So curious if you could frame further the size of the demand that you're seeing? And maybe it's helpful to think about it because of the way you disclose under a megawatt demand versus over a megawatt demand, and just try to think about the funnel and the opportunity, including from Gen AI workloads. Matthew Mercier Yeah. So I mean, like I said, this is a strong demand environment as I've seen in quite some time. And I think a lot of the attention gets on the greater than a megawatt hyperscale AI segment, which as it should, that's where we're seeing sort of the outsized growth and where we're seeing the increase in terms of -- the material increase in terms of our pipeline from a demand perspective. But I think it's important to note, again, that it's not just AI, we still have within that funnel a solid amount of demand from the more traditional cloud and digital transformation workloads as well. And on the 0 megawatt to 1 megawatt side, I think what we're seeing there is a continued steady, stable and growing demand set from within that business. I think part of that is not only are we continuing to focus on that as a company, as a business when perhaps some others aren't, so we're able to, I think, take market share within that segment and really focus on growing that while we're also able to, I think, utilize the heritage and the relationships we have to continue to grow within the hyperscale segment. And just to try to frame some of the -- you asked about the overall, I think, just demand picture, to kind of try to frame that. So first quarter of this year, we had a record signings quarter. We had over $250 million of bookings. We followed that up in the second quarter where we had a little north of $160 million, so not a record, but a very solid quarter in terms of overall signings for us when you look at it from a historical perspective. So that generated a first half total of north of $400 million of bookings, which is twice the amount that we had at the same time in the prior year. So kind of I think demonstrates sort of the type of demand and pipeline oriented and success and execution that we've had. Now that's the total amount of signings. And within that, we continue to have, what I'd say, very strong and steady bookings within the 0-1 megawatt segment. We've signed over $50 million a quarter over the last several quarters, and we've seen pickup within our interconnection bookings as part of that. So I think we've been able to successfully execute within both of those segments over this, what's been again a rising and steady view of our demand across our global portfolio. Michael Rollins And so if we unpack that a little bit more. So the over $50 million from the under 1 megawatt side. As you look at the pipeline that you're developing for that and you look at the demand, is this something that not only may sustain, but you might even be able to augment this opportunity over time, especially I know over the last few years, this has been an increased point of emphasis and focus for the company? Matthew Mercier Yeah. I mean we're continuing to, I'll say, invest and stay focused on growing that segment of the business globally. So the way we're sort of approaching and attacking that, so we look at it from both where within the customer base, where can we expand, call it, share of wallet within the existing enterprise-oriented customers we have. So we have a focus on growing our -- within that segment, looking at our enterprises that are, call it, $1 billion plus in revenue, really looking at where we can expand them across, take advantage of platform Digital, the 50-plus metros we have, the 300 data centers, where do they -- where do we think that they can -- we can land and expand them and really, really taking advantage of those existing relationships and the value proposition we have and grow them across our global portfolio. At the same time, working to cultivate new relationships with customers. And so that's why you'll hear us usually every quarter focused on new logos that we're generating, where we've been generating north of, call it, 100 new logos a quarter over the last several quarters. It's really part of cultivating hopefully what would be the next set of large enterprise customers that can grow with us within our portfolio within that segment and really expand. But for the most part, if you look at our signings, the majority of signings within any given quarter, and this translates to both the 0 megawatt to 1 megawatt and the greater than a megawatt segment. The majority of our bookings still come from our existing in-place customers, which we have over 5,000 of, but we're also making sure that we continue to expand that customer base and provide us opportunities down the road to further grow our existing customers and their share of wallet. Michael Rollins And as we shift over to the over 1 megawatt, it may be easier to ask this question just in totality, whatever is the way that Digital looks at it. What percentage of the demand right now or the bookings are coming from Gen AI workloads? And how does that compare to what's in the pipeline? Matthew Mercier Sure. Yes. So I mean, if you think about spending a little bit over a year of sort of the AI -- the AI discussion. So back when NVIDIA kind of first did their -- blow our quarter, which was, I think, in May, May-ish timeframe of '23, so we started talking about on our third quarter '23 call in terms of like percentage of AI that was within our signings. That point in time, it was called roughly a third of our signings back at that point. Fourth quarter was relatively de minimis. And that kind of fits within sort of the pattern that those greater than a megawatt, and this is back when it was more cloud-oriented versus now cloud plus AI, you do see fluctuations in terms of the overall volume just given the size and the types of workloads that we're talking about. You then shift over to 2024, the first quarter, which is our record quarter, $250 million. We talked about half of those bookings were AI-oriented. Second quarter, it was around a quarter of those were AI oriented. And in terms of our pipeline, I would say that we're seeing -- there's a material amount of our pipeline that's overall AI-oriented in terms of expectations. But there's also -- because again, that's been sort of the adder on top of our existing pipeline. We're still seeing very robust demand from existing, call it, traditional workloads around cloud as well. Michael Rollins As we try to think about the bookings opportunity over time for Digital, is there a way to frame just how much physical capacity that your sales team is out there, marketing to current and prospective customers? There is, of course, the part of your capacity that's built and underutilized relative to its potential. There's the stuff that's in development. But then there's also projects, right, that sit in kind of the waiting room where you could just greenlight those if you get the customer demand. So how should we think about like the total quantum of opportunity that your sales team is bringing to market? Matthew Mercier Yeah. I mean I'll dive a little bit into this, but the simple answer is our sale. We've got close to 3 gigawatts of potential capacity outside of our 2.5 gigawatts of operating capacity today. So in general, we could double the size of our business. And our sales teams can, in essence, market all of what's available within our operating portfolio and the majority of that 3 gigawatts that could be built out. Breaking that down a little bit further, we've got close to 430 megawatts under development today. Roughly 65% of that's leased, pre-leased, so there's an immediate availability within that 35%. We're then building around a little over 700 megawatts of shell capacity. So that's kind of the next stage of most near term that would be available. We've got line of sight on power for the majority of that capacity as well. And then we have, call it, close to 2.3, 2.4-ish gigawatts of, in essence, land capacity available. And I mean, we've had -- we talked about last quarter, we had an opportunity in Dallas where we, in essence, sold what was not even underway, it was land capacity, and so we've seen where we've been able to sell through kind of all three of those different stages of potential available capacity that's within reach within our portfolio today. Michael Rollins So with all this capacity that you could tap into and sell, is there an opportunity for another record bookings quarter second half of the year? Matthew Mercier Yeah. I mean I'd almost go back to, I think, something that Andy had said on, I think it was our first quarter call when we had our record, that it's hard to do back-to-back records, which we didn't do. We've already had the second quarter. But look, we've got -- with the demand environment that I think we're in today, the capacity that we have available, that's highly attractive to not only the hyperscale community, but also, again, not to ignore our 0 megawatt to 1 megawatt business that's doing well as well, I think there's definitely opportunity for that potential to happen. Michael Rollins And how do you think about the -- like where it goes, like what gets funded on balance sheet versus what might go into the joint ventures? Matthew Mercier Yeah. I mean so we've sort of -- I mean not sort of, we have -- I mean, we've done that today. Someone answered that. So we've done joint ventures. Our joint ventures, one aren't necessarily new to Digital. We've had a number of joint ventures over our history. And they largely fit in kind of two broad buckets. One is, where we're utilizing financial capital-oriented partners, which is, I think, a little bit more of what you're referring to, and others were, call it, more strategic or operational, and those would be ones like Ascenty in South America, where there's actually an operating partner company, management team generally behind it. So like Ascenty, Teraco in South Africa and Mitsubishi in Japan, where it's helpful either from a risk or other strategic rationale, bringing in demand in local, more localized expertise in having those partners. From the financial capital partner side, we've expanded on those relationships over the last year. Most notably, I think you're referring to the Blackstone joint venture, which is roughly a $7 billion JV. We've closed the first phase of that, which we did early this year. We expect to close the second phase sometime in the second half of this year. And that's roughly 500 megawatts of capacity across three different markets, expect to deliver probably 20% of that capacity in '25. So that's going to be a multiyear sort of journey as we look to -- which is part of that $7 billion in terms of their capital commitment to those sites. And again, I think that just goes back to the fact that this hyperscale opportunity is large. We think it's prudent to have capital partners with us that can help fund that development. We earn incremental return on our invested capital because we're generating fees, and in some cases, related to development projects. We're generating those fees kind of right away from the start so it has an impact to our bottom line as well. And so we think those will continue again as those are just getting started, somewhat of a multiyear journey as we look out to the capacity that's available within that JV. Michael Rollins One of the questions that we get is whether or not this strong demand cycle is going to get to a point where there's just been more absorption by the customers that may be needed for the workloads and it could create some kind of correction in the supply-demand environment. As you kind of look back to the cloud cycle that you went through, where we saw some of those ups and downs in terms of supply-demand environment, are there any learnings or indicators that you can -- you learned from back then that we should be mindful of today? And because of the power constraints, is this just a fundamentally different environment? Matthew Mercier I think there's a little bit of the two parts, both of those parts that you just mentioned. So from a power constrained business, I mean, we haven't seen this type of constrained environment in, you call it the history of data centers, meaning it's not -- what started as a focus on power constraint largely within the Ashburn market, which is the largest data center market in the world, has now extended across multiple markets, not only in the U.S. but also globally. So I think that constraint alone has kind of, call it, created a level of ceiling where it's more difficult to bring power and be able to satisfy the demand that's out there today, which has also what's led to improvement, substantial improvement in some markets in terms of pricing. And so it has accrued to I think us, as an operator, especially an operator with one of the largest existing operating capacities across several of these markets, including Ashburn in Northern Virginia. So I think that kind of sets sort of the stage around how things are a little bit different this go around. In addition to that, I think from our lens or from how we're -- how we look at it, and a little bit to your point on what have we learned. I think one of the things we're also doing is we're sticking to our core markets. So part of what's happened is you've seen some of this demand go into spillover secondary, tertiary or however you want to describe it. Other markets largely within the U.S. because that's where most of the AI demand is oriented today, although that's starting along the same -- some of the lines of cloud to trickle through into EMEA and into APAC, but still in the early innings of that. But we're sticking to our core markets where we think over time, we see a diversity of demand that I think should enable us to withstand any sort of disruption or slowdown that might occur, although based on what we're seeing in the pipeline. I mean, we don't -- we're not seeing that they're expecting that anytime soon. And I think that -- in addition to that, where we do -- where we are starting developments. I mean, some of the data points we already mentioned, we have a pipeline, development pipeline that's already 65% preleased. We're releasing these to customers over a long-term basis with good to annual escalators in 3% to 4% area. So I think kind of -- and most of these, most if not all of these customers are very high credit quality customers. So given that sense of security, stability around what we're doing and looking out into the future to be able to sustain any sort of disruption mine or major from our lens. Michael Rollins We switch gears to pricing for a moment. So with pricing, you and the team over the last number of months have talked about the positive pricing conditions. If you just take out some of the outliers, whether it's helpful or hurtful outliers, is there a way to frame kind of the average rate growth you're seeing? And I realize you can look at renewals, but really more from a spot price market perspective, what you're seeing? And are you still seeing that growth now continue into this third quarter? Matthew Mercier I mean the short answer is, I mean, yes, we are continuing to see positive pricing momentum across the majority of our major markets. And that there are different degrees of that. As you mentioned, I mean, Ashburn has seen sort of the largest -- had the largest decline over several years ago, and as a result, has also seen the biggest uptick and reversal of that trend. So that might be one of the kind of outliers you mentioned, but to use that as an example, we've seen rates that were in the 80s, now they're in the 160 and beyond. And so we've seen that sort of relatively quickly rebound in pricing there. But I would say broadly across most of our global markets, we've seen sort of over the last, call it, two years, which is where a lot of this kind of supply-demand imbalance started to really take shape, we probably see anywhere from mid- to high single-digit sort of annual growth in terms of where rates are across most of those major core markets. Michael Rollins And are customers changing the way they engage with the renewal schedule? So are you seeing any change in behavior because of the pricing conditions, customers may want to come to you early and say, what, let's just extend the leases now off what the market is today and defer the risk of things even getting more expensive as they look out over a couple of years? Matthew Mercier I mean we're seeing -- it's I would say, that's relatively isolated at this point, but we have seen that. So we talked about -- we actually talked about one of those on the first quarter. We had sort of an outsized mark-to-market in the first quarter, and we had sort of talked about that in terms of a sort of a preview, if you will, or an illustration of an outer year -- an outer year expiration that was pulled forward into '24. So kind of demonstrating the pricing potential and the uplift for -- as you get sort of further out into our lease expiration schedule. So we've seen that in certain instances, not -- I wouldn't say that's a widespread phenomenon, but I think there's opportunity for that as we start to move through in this environment, continues in terms of a supply-constrained environment, there's potential for that to continue to happen. Michael Rollins So we're starting to learn more from some of our other coverage around hyperscalers signing 20 year IRUs for fiber. And curious, first, if you know if some of these fiber deals are going to your data centers, and if the IRUs are being signed for those longer durations, I think that's longer than the typical initial contract for your hyperscalers. Does this just reinforce the durability of the leasing opportunity from this evolution in workloads? Matthew Mercier Yeah. I mean so we've started to see some of that. I mean, most of our -- the majority of our portfolio, we already -- for most of it, we already have existing connectivity, so I think we're starting to see this in some of the new builds that we have and building out sort of that connectivity oriented, some of which is -- some of which we help procure, some of which depending on the size and how much of the data center a customer has. There can be the ones more on the forefront of procuring some of that, some of the dark fiber. But that's always been part of, again, back to sort of that being able to combine both not just the hyperscale, but being connectivity-oriented. We've been working with our customers as well as the network providers to bring in connectivity to all of our sites as much as we can. And in addition to that to working with our customers to also connect sites within a campus. So I think one of the things we're seeing that is preferred by customers, but again, it kind of depends on the mix of how much power is available and their time to market. But what we're seeing is there's a preference for customers to land sort of AI requirements near cloud compute because cloud is where a lot of the data is held. So their ability to connect from a building that's on the same campus to where they have an AI workload and using pathways and other connectivity options to bring those two data sources together, I think is an ideal environment, something that we're helping our customers to solve. Michael Rollins Maybe pivoting over to the financials. So in terms of capital allocation, dividend has been flat for, I think, at least a couple of years now, the annual dividend? Over a year. What's the path? And what should investors look for on the possibility for dividend per share to return to annual growth? Matthew Mercier Yeah. So I mean we're -- the way we look at it, I mean, we view our best -- our best source of capital is internally generated cash flow. So that also focuses driving growth in internal cash flow that we can then deploy into development yields that are in the 10% plus area. And I think as we look to do that, and as we start to grow the bottom line, ultimately, that's going to be sort of the trigger to then look at and say, okay, we're now looking to grow ultimately our dividend in lockstep with our bottom line, so call it core FFO, AFFO per share growth, but also looking to, again, maximize, I think, the amount of cash flow that we're able to retain, which is not easy given that we're restructured. So we're distributing the majority of our cash to begin with. But to the extent we can satisfy both, we can maximize cash flow available from operations after dividends to help fund some of the development growth and the higher yields that we're seeing and also start to continue to grow our dividend as our bottom line growth take shape as well. Michael Rollins In the past -- over the last number of months, you framed the conversation on equity, it's around partly opportunistic related to the demand environment. Is that still the way that you look at the possibility of equity or do you prefer, especially now that you have the additional capital partners that you have, to create more of a self-funding model for Digital with the internal cash flow and the benefit you get from levering EBITDA growth to kind of fund the investment needs for the business? Matthew Mercier Yeah. I mean in the most ideal world, I mean, we'd be able to satisfy our capital need from self-funding. I think we're right now, in our environment though, I think we're at a place where that's why we've set out on a path to have a diversity of capital sources available. I think the statement still hold around equity being demand-oriented, right? I mean we're seeing that as part of this capital deployment, investment in our development pipeline where, again, we're earning 10% plus returns, which I think is a good use of overall capital and I think good returns that most shareholders would be happy with. And so I think we're looking at how we can, again, put together the right mix of capital sources across not only cash flow from operations, leveraging EBITDA growth that we have now that our balance sheet and leverage are in a good place, access to debt capital markets and then supplementing the equity side with a mix of both JV capital partner sources as well as public equity where needed. Michael Rollins And just to finish up, you spent a good amount of time, I think, with investors since the earnings. Are there any aspects of the Digital Realty strategy story opportunity that you feel may be underappreciated at the moment? Matthew Mercier I don't know if anything is underappreciated. Look, I think we've done a lot over the last year, again, in terms of getting the balance sheet back in place. And ultimately, this is around growing the bottom line, which is why that's our first, second and third focus. And we're in the environment where we see a path to be able to do that, just given the positive pricing environment, the yields we're seeing on developments and the overall demand environment, I think, sets us up well to be able to execute and deliver on that.
[6]
MetLife, Inc. (MET) KBW Annual Insurance Conference (Transcript)
Michel Kalaf - President and CEO John McCallion - CFO and Head of MetLife Investment Management We do have cushiony chairs up here relaxing. I'm Ryan Krueger from KBW. I cover the life insurers. It's great to have MetLife back with us again this year. Up on stage with me is Michel Kalaf, President and CEO in the middle and John McCallion, CFO and Head of MetLife Investment Management on the right. I also want to acknowledge John Hall, Charlie and Misha from Investor Relations. So I guess just to start, you're approaching the completion of the next Horizon strategy, which was a five-year strategy. You have an investor day scheduled later this year to discuss the new strategy called New Frontier, I believe. So to start was hoping you could reflect on your performance over the past five years and also any preliminary thoughts on what we should expect for the next five-year strategy? Michel Kalaf Sure. And great to be here, Ryan. Thanks for having us back this year. So if we look back at sort the environment, the industry, MetLife from five years ago compared to today, I would say there's a big difference. So from an environment perspective, back in 2019, we were looking at historically low interest rates. We were also just right around the corner was a global pandemic with significant human and economic cost to follow. And if you had asked me five years ago where disruption might come from for the life insurance industry, I would have probably pointed to insure tax who are looking to zero in on certain sort of components when it comes to the value chain. So fast forward five years and today, interest rates have rebounded, the reinvest rate exceeds the roll off rate. The pandemic has become endemic and to a large degree, we're back to a [BAU] type situation. And what we're seeing from an advancements in technology, whether it's AI or technology more broadly, suggests that incumbents have an advantage here to convert their scale into a real their size into a real scale advantage. And so it's a different environment, I would say. And there are also some population shifts that also support sort of renewed momentum in the industry. So if you think about that, you think about demographics, you think about a more stable economy, I think that's all sort of putting the industry in a more of a growth mode today compared to five years ago. For MetLife I think for us five years ago we were in approve it mode. And this is why we came out with an aggressive set of commitments, five year commitments. We're very much on track to exceed all of those commitments. So namely, we talked about $20 billion in distributable cash. So we will exceed that. We talked about $1 billion in operating leverage to reinvest in growth and in technology to support our business. We will exceed that as well 13% to 15% ROE. And again, we are sort of clocking higher than that currently. And then a 65% to 75% two year free cash flow target, which we've exceeded throughout the Next Horizon period. So, we feel good about our performance throughout this period about how we're positioned going forward. So, as we think about New Frontier, we will look to build on the success that we've achieved during the Next Horizon period. And here I think there are -- whereas maybe back in 2019 we were more sort of on the defensive. I think we now are more in a growth and offense mode. New Frontier will look to build on the strong foundations we achieved on under Next Horizon, and really look to accelerate our growth to boost our returns and to basically ensure even greater consistency in our performance and our results. I would also point out that beyond achieving the commitments and targets throughout Next Horizon, we also continue to reshape our business. And here we've made, I would say timely acquisitions and divestitures, managed to redeploy capital, again which makes us an enterprise that has a lower risk profile, but also has a lower range of potential outcomes as well. So don't think about, New Frontier as a departure from Next Horizon. We are not looking to go into places where we don't feel we have a right to win. This is really a growth platform that is intended to build on Next Horizon and to take us to what we believe will be new heights in terms of levels of performance going into the future. And of course, we look forward to sharing more at our Investor Day on December 12. Great, thanks. So you mentioned that you're exceeding the 13% to 15% ROE target. I think the original target was actually 12% to 14% as well. But when we look at the first half results, I think your ROE was 15.5% and that was even after having your kind of lower variable investment income than the long-term assumption. So, the question is do you see the ROE continuing to expand from here as you have MetLife holdings continue to gradually run off and you've been illustrating for several years that your new business IRRs are more like in the 17% range. John McCallion Yes, I think you summarized it pretty well and I think just if you take some of the comments that Michel just made and as you highlight, we started out at 12% to 14%, we've been in ROE expansion mode for the last five years, right? And I think those factors that you just highlighted are certainly key. A few other things I would just kind of call out, right? I mean, I think the rising rate environment has been beneficial. So while new business, we've been high -- generating high teens IRRs, that's unlevered. The roll off reinvest has been a powerful tool as well. And I think, you have got to bring into the fact, our risk profile has changed, where our -- how capital intensive we are has changed. And so all of those things and those factors have been beneficiaries in terms of our ROE. And I think, we would argue that's probably continuing. We're definitely punching at the high end, if not above that, for this year and VII is below trend. So, if you get back to full strength, we expect to continue to post high teens IRRs at this juncture. In terms of new business, we see the roll off of holdings continuing. That's probably a high single-digit ROE business, right? So that kind of continues to migrate down. So there's certainly momentum for the ROE to be accretive from here. And as kind of -- as we saw in Next Horizon going from 12% to 14% to now the high end of 13% to 15%, I think it's fair to say that there's opportunity ahead of us. Ryan Krueger On VII specifically, it's been improving but still a bit below your expectations. Can you give any update on what you're thinking for VII in in the back half of the year, maybe relative to the first half? Michel Kalaf Yes. It's -- we gave an outlook on it. We said that we thought return would continue to start to migrate upwards. We've seen that in the first half, we saw some pressure in real estate early, but offset by some probably a little bit better than expected PE returns. Remember, we have about $19 billion in total about $14 billion of that is PE. And then we have other funds, real estate and other funds. And so we saw a little better performance in PE. We think -- we thought the next second half of the year would be kind of upward trajectory. We still think there's an upward trajectory from here. For third quarter, early days here, but if we extrapolate what we're seeing so far, we're running a bit below Q2, probably 50%. So we're seeing PE a little bit of have some headwinds still positive. We're seeing real estate recover, but overall for the Q3, we're seeing about 50% of what we saw in the Q2. We still think we're on that upward trajectory. I wouldn't change our view of Q4 on, but we are seeing a little pressure in the Q3. Ryan Krueger And then it's just one more related question. You had for the outlook for this year, you had brought down your VII assumptions. Was that intended to be more of a 2024 view or should we think about that more as your view over the next few years? Michel Kalaf Yes. So we still think that returns would migrate upwards, but one of the things that we've been seeing over the last several years is we are probably in a net distribution mode. So rough justice distributions have been north of $2 billion for the last three years. We actually think that's going to continue to tick up, right? So we think returns will grow, but maybe the quantum of earnings may not because your balances are coming down a bit, right? So kind of our mix shift and we've talked about this at a higher rate environment. We might kind of move in the margin a little lower in terms of our allocation to this asset class and so but distributions have been coming in strong. So off of, like, $14 billion of book value, we're seeing north of $2 billion a year in distributions. We think that probably grows in the outer years. Ryan Krueger Got it. Shifting gears to group benefits there have been a lot of questions about the competitive environment lately, just given favorable industry returns for a lot of companies. What's your view on the competitive environment in group benefits and also have you really seen it change much over the past year or so? John McCallion Yes, I would describe it as competitive but not irrational. And that's been consistent over the past year or so, I would say. I think trends have been -- returns have been favorable in the industry. So you might see a competitor from time to time get overly aggressive. But I wouldn't sort of -- I wouldn't point to anything that's irrational here. Price matters and is important, but I think we've talked in the past about the importance of investing in this business and building capabilities, because it's not just price. It's more than price. And I think we're seeing that in an even more pronounced way, I would say, in terms of what customer expectations are. And that continues to be a factor in terms of not only winning new business, but also continuing to achieve very healthy persistency in this business. Ryan Krueger On the growth side, you've been targeting mid-single digit premium and fee growth in group benefits and you've been achieving that. I think a question that often comes up is you have a large market share in this market. How are you still able to grow kind of, at least in line, if not maybe above the market? So can you talk about kind of what's driving that and also to what extent does it differ between some of the key market segments that you compete in? John McCallion Sure. Very pleased with our growth above market growth consistently over sort of the Next Horizon period. And if you look at, you say, well, at 5% growth rate is healthy for this business, I would just -- I think what's more impressive from our standpoint is the fact that we are growing off of a very significant base. And so this 5% growth translates into more than $6 billion in PFOs over the five year Next Horizon period, which is the equivalent of a reasonable size player, I would say in the market. So very pleased with that. And we are confident in our ability to continue to grow this business. We've been -- our strategy has been to identify secular trends that will drive growth in a group and then to be laser focused on investing in capabilities that differentiate us and continue to drive our competitive advantage. And whereas there are some trends that are, I think well publicized in terms of -- if you think about employers continuing to see benefits as a key component and their ability to attract, retain talent also in terms of engaging talent and ensuring better productivity. I think those are things that the entire industry will continue to benefit from. But there are, a few maybe less talked about trends that I would point to where we see a real opportunity also for MetLife. And three areas I would touch on here. One is the complexity that employers are telling us they are facing and this is a real issue. And the ability to solve for that is an important consideration. So think about complexity when it comes to the number of providers that companies have to deal with. Think about complexity in terms of the benefits, human capital ecosystem that employers have to deal with. And I would sort of particularly also note complexity when it comes to leave and absence management due to state-by-state regulation. So that's a real pain point that we've been hearing about from customers. And on all of these fronts, having the largest and widest product range in the industry allows us to help customers consolidate with fewer providers. Having seamless connectivity to that benefits ecosystem also helps us simplify things for customers and important investments that we've made in building best-in-class leave and absence management capabilities. My Leave Navigator being our flagship product here is allowing us to win significant business. Just to give you a sense of that, through the five year Next Horizon period, we have more than doubled the number of covered lives when it comes to leave and absence. And overall, 80% of our sales in the national account space, the 5,000 plus market, come from existing customers. So that's one area. Another area that I would point to is the consolidation that's taking place has been and continues to take place in the broker intermediary market, where we are seeing bigger brokers consolidate some of the smaller ones, especially in the lower and middle end of the market. And again, here, given our relationships with those brokers, given that those brokers like to focus on a select panel of best-in-class insurers, this is giving us added access to that segment of the market that is quite fragmented. And then maybe one last thing that I would point to here in terms of -- from an end user or from an employee perspective, all surveys point to the fact that close to 50% of employees say that they are confused when it comes to choosing their benefits. And I think all of us have participated in enrollment and re-enrollment exercises and maybe we can attest to that. And so here, again, we've invested in a capability, a significant investment to really help employees select wisely, but also to ensure that they have a seamless experience in terms of how to use products. And this is true for life and health. We are deploying this capability in the market. And if you consider that currently for voluntary products, our take-up rate is in the low teens, there's a lot of sort of room for that to grow over time. So I think we feel good about sort of the momentum that we have in this business, but also about the future trajectory in terms of our growth here. Ryan Krueger Sticking with group benefits on the underwriting side. Can you discuss the underwriting results you saw in the first half of the year as well as any key trends you're seeing in the different product areas? Michel Kalaf Sure. I would say that what we've seen in the first half is largely seasonality being back to pre-pandemic levels. So if you think about the first half, our life ratio is at the low end of our range, 84.6%, whereas -- or 84.7%, whereas non-medical health was slightly above the midpoint of the range. On the life front, we saw, as we typically would, higher loss ratios in the first half of the -- in the first quarter of the year. The second half benefited from, and this is consistent with what we saw from CDC data, favorability in terms of the working-age population mortality had dropped. We don't think this is necessarily a trend. We think that we're more likely to revert to more normal seasonality, which means that in Q3, that's typically our lowest quarter when it comes to the life ratio. So we would expect Q3 to be at the low end, if not slightly below our range. And then on the non-medical health front, this is primarily dental and disability. I think dental, we saw sort of seasonality revert where plans reset in the first quarter. That tends to be a high quarter. We saw utilization drop in the second quarter. And I would say, last year -- beginning of last year, we were seeing an increase in the trend in the dental trend. So we did take pricing action. We were proactive on that front and that's largely behind us. So I would expect sort of the experience to continue to be consistent with what we would see in the past. And then disability, I would say, has been -- we benefited in Q2 from a non-recurring reserve adjustment. But that aside, I think our -- the experience there is consistent with our expectation, slightly higher utilization, offset by lower severity and strong recoveries. Ryan Krueger Great. Moving into your retirement income solutions business. The spreads, excluding variable investment income have been declining in recent quarters as your interest rate caps roll off. Can you give an update on expectations for spreads in that business in the back half of this year? And then, also just any thoughts on how to think about it as we move into 2025? John McCallion Yes. Sure. And as you mentioned, we had these caps on. We bought them a number of years ago for this exact environment. When we see kind of a sharp rise in rates, the front end of the curve can put some pressure on spreads. These caps have hedged that, right, and it gives us time for the long end to find its way to roll off and reinvest into our earnings. And so that's basically happened. As we've talked about, the cash will mature this year and they kind of do 1/3-1/3-1/3, first quarter, second and then third. We expect that to result in about 8 bps to 10 bps a quarter of declining spread and then flatten out in the fourth quarter, and I'd say generally in line with expectations. I think the second quarter probably came in a little better. I think rates were a bit higher than we had thought they would be, but we still think the third quarter will be 8 bps to 10 bps off of where we were, 2Q. We'll give more perspective at the outlook on 2025 because a lot matters with the curve. But I think at least -- the curve is expected to steepen, which should be a positive and I think to kind of stabilize spreads, especially as the caps have rolled off. So that's maybe a good way to kind of frame it for now. Ryan Krueger Got it. In that business, you have a target to grow spread based liabilities 2% to 4% a year. You've kind of generally been exceeding that some lately. Can you talk about where you're seeing the best growth opportunities in that business? Michel Kalaf Sure. And RIS is an important source of earnings and cash for the company. I would say we're diversified at scale in terms of our product set there, which allows us also to perform across a range of different environments. To the point you made, we have seen healthy growth in our spread business. The -- we have $157 billion and liability exposures in our general account that's benefited from momentum that we've seen in several of our businesses. PRT is certainly one. Over the last couple of years, we've written about $20 billion in PRT business. So that's been a contributor. And whereas PRT can be lumpy, clearly, with our focus on jumbo -- on the jumbo end of the market, it can have -- it does have an impact in terms of our growth there. We continue to see a healthy pipeline there. If you look at funding levels, continue to be very healthy, higher rates, strong equity markets help there. So we believe that this market is going to continue to grow. And we're focused on the jumbo end, where we think that with our investment capabilities, underwriting capabilities, balance sheet strength, credit ratings, we would continue to win our fair share there. Another business that I would point to is structured settlements where post pandemic, we saw sort of court activity resume. Higher rates also are helpful to this product. We're the market leader there, continue to achieve very healthy return and we continue to see strong momentum. And then I think we've been also focused on RIS on product development and I think that's contributing and will continue to contribute going forward. Think about UK longevity reinsurance, which is a business we entered in 2020, and it's exceeded $20 billion so far in terms of business that we've written. So we feel good about sort of our -- the mix of business and our ability to continue to grow our liability exposures there. Ryan Krueger In Asia, you sell a diverse set of products that includes annuities, life insurance, accident and health. Can you talk broadly about kind of how does the interest rate -- the higher interest rate is somewhat higher -- interest rate environment? How is that in Japan impacting demand for the products as well as we've seen quite a bit of FX volatility recently? Michel Kalaf Sure. Japan, again, is a very -- and Asia are important markets for MetLife. Japan contributes call it, $1 billion or more a year in earnings to the company. We have a very, very strong presence there, 50 plus years, 6 million customers and diversified set of products and distribution. And I think post pandemic and during the Next Horizon period, we've really credit to our team because we have managed to outgrow the market from a sales perspective, from a premium income perspective as well. Our premium income growth is more than double the market growth. And the strength in our distribution and product is important. If you think of it from a distribution perspective, we are the #1 player in the general agency market, which is an important distribution channel. And we're top 10 in all other channels. And from a product perspective, we're #1 on the -- in U.S. dollar products, and we're top 10 in all other product categories as well. To your question specifically, what - two things are happening from -- in terms of FX products in Japan. One is it's a tough compare year-on-year. Last year, we grew 14% in Japan. So this year, growth was always going to be challenged by that. And the second factor, whereas the interest rate differential continues to be attractive, the fluctuation in currency in yen has a bit caused people to sort of take a wait-and-see attitude in the first half of the year. With a more stable yen of late, we are seeing that moderate. So we're seeing an uptick in terms of demand for these products. And we think that should continue for the balance of the year going into next year. And the other thing I would say here is that and you also mentioned this, Ryan, that we're not just about U.S. dollar products in Japan. We launched a yen VUL product and a cancer -- yen cancer product late last year. Those products are doing extremely well, and we have other also products planned in the pipeline. And we think with yen rates potentially inching higher, we're going to see more opportunity on the yen front. And maybe one last just taking a step back, one last comment on Japan. I was there a few months ago. And after decades of stagnation, I think there's renewed energy in Japan. What's happening is that with an uptick in inflation, that's potentially leading to wage growth, which is also leading to an increase in consumption. So I think it's for the first time in a long time, it's a different dynamic. And considering that close to 50% of savings sit in cash and bank deposits, which is punitive in a higher inflationary-type environment, the government is very interested and encouraging that -- those savings to move into other instruments. I believe that over time, the industry would be a beneficiary of that. And as a leader in that industry, I think we're very well positioned to take advantage of that as well. And the last comment I would make is that as investors consider beneficiaries from this change environment in Japan, I think MetLife deserves consideration there. Ryan Krueger I guess in Latin America, as you've emerged from the pandemic, you've had really good growth there. Can you talk just about what's really driving that? And do you see any risk to this momentum continuing from here? Michel Kalaf Yes. I mean very -- really pleased with the momentum that we've seen over a number of post pandemic, I would say, in LATAM, and I think that's being sustained. We're market leaders in LATAM overall, and we have very strong positions. We're the #1 -- we're very -- we have very strong positions in both Mexico and Chile, #1 player in LATAM overall and a strong emerging presence in Brazil. The growth that we're seeing, I would attribute to a few things. One is our core business, we're continuing to grow that and diversify it. So if you think about Mexico, for example, our flagship business there is our worksite government business, where we have a very dominant position. And whereas we've managed to continue to grow that business, we've also transferred a lot of the know-how and experience from that to the private sector. So if I look back five years ago, sales from private were about 50% of our overall sales. Today, they're about 70% of overall sales, whilst continuing to grow the government sector as well. And that's due to, again, product and channel diversification, strong distribution capabilities that we have and investments that we've made in technology as well. And then Brazil has been a really good story for us. We're growing at 3x the market there, 30% growth rates. An interesting development in Brazil is the -- how native financial institutions, digital natives have really sprung up and taken significant share in that market. So this was a market that was dominated by the four largest banks and they had also a major share in the insurance sector. That's now opening up through these digital natives. And we invested in a capability that we are calling accelerator that allows us to integrate seamlessly with these digital natives provide embedded insurance, integrate into the customer journeys rather than create a separate journey and we're seeing really significant traction from that. We have more than 3 million policies already on that platform, and we think that number is going to grow significantly as we move forward. We also think that this capability is transferable to Mexico and Chile, where we have also strong positions and obviously a very strong brand. So we feel good about our sort of growth prospects in LATAM. From a risk perspective, I would say, you always have to keep an eye on the political regulatory environment there. Nothing that we see on the horizon that would cause us to be concerned but it's something that we certainly keep an eye on. Ryan Krueger The questions on commercial real estate have died down some, but I'll still ask one. I guess, can you just give us an overall update on how your commercial mortgage loan is -- portfolio is performing in the current environment? John McCallion Yes, they died down until you just asked that question. But no, it's generally performed as we've expected, I think since kind of the pressure started a few years ago, and I think partly due to the fact that we're a well-seasoned real estate manager. And I think even -- and the way we kind of approach this, and really the industry for that matter, is to -- is more thinking about cycles, right, and kind of managing for the long-term. Our portfolio, even though distress, has got an LTV of 66%, debt service coverage ratio of 2.2x. And we probably think we're kind of close to the trough of this cycle. I think last year on a $50 billion portfolio, we had about $20 million of charge-offs. We think that will grow a little bit this year but still be south of $100 million. So very modest kind of loss expectations relative to what some have said is a very stressful real estate environment. I think a couple of factors, right? One is how you manage the portfolio. And I think, as we said, we kind of -- we always go into these situations, into these investments with the idea that we're going to hit a cycle, right, so kind of thinking about origination in the 50% LTV ranges when we underwrite loans. I think two is the economic environment has actually been pretty positive. And that's a positive for real estate I think third is when these cycles hit is -- the first thing that kind of happens is construction moderates, so the kind of fix the supply and demand. And that tends to kind of fix situations and kind of allow things to come out. You saw that in like strip malls is a great example years ago, right? And now it's one of the hottest places for real estate. And I think the third thing that's emerging, right, is with the expectations of rates moderating, right, maybe even coming down in the future, you're starting to see that kind of find its way through people's view of the outlook, appraisals, things like that. So all in all, I think we feel very comfortable with the portfolio. It's well diversified. We have a great team and platform to manage it. We're both on the debt and equity side, which gives us an advantage. And we think that while we'll have some charge-offs, it will be very modest over time. Ryan Krueger Great. We've seen a number of life insurers established third-party capital site cars. Is that something that could be of interest to MET in the future? Michel Kalaf Yes. I mean, I think -- of course, it would be. If you think about our sort of philosophy approach, it's always about deploying capital to its highest and best use. And we want to continue to make sure that we take advantage of growth opportunities. And I think you can see from our disclosures how we've been deploying capital in support of new business at mid-to-high-teen IRRs and healthy paybacks as well. And I think so far, we've been able to fund this from our own balance sheet. I think in a higher-rate environment, we do see -- we'd expect demand to accelerate. And given our strong liability origination capabilities, it's important for us to build optionality here in case demand exceeds our capital generation. There are different sort of tools that we can use here, internal reinsurance, external reinsurance and third-party site cars is another form of external reinsurance, if you like. So -- and we have access to some of these tools. Obviously, we deployed them, as you've seen also with the Global Atlantic transaction, for example. So -- and again, we think about this also as we think about growing our asset management business, MIM, in terms of how that can be also a vehicle to allow us to provide access to third-party capital to some of the strong origination capabilities that we have within MIM. So that's a little bit how we look at this. Ryan Krueger John, you touched on this a little bit before, but can you speak a little more broadly on how we should think about Met's sensitivity to both short-term interest rates, long-term interest rates and, I guess, the slope of the curve? John McCallion Yes. And we give some sensitivities annually on that. And I think the last one there was off of year-end of last year with the forward curve, and then we gave some kind of parallel shift of 50 basis points up and down. And I think those are fairly good kind of expectations even where we are today. So it's a fairly modest uptick in earnings on a 50 bp move and similarly on a decline. I think the shape of the curve, to your point, is probably the more interesting one right now. And we do see a steepening, and that would be -- that's beneficial, right? And we would think that's kind of the ideal situation is kind of these higher rates. And we won't -- we don't call them high, but we'll call higher rates but with a more -- with a steeper curve. That's generally where we can perform kind of the best across all of our businesses. So kind of our outlook would indicate that we think that will be beneficial. And certainly, as these caps roll off, as I said earlier, that would be kind of a beneficial outcome. Ryan Krueger Great. And then final question was on capital management, just how you're prioritizing buybacks, dividends, M&A and also, if any further divestitures would also be considered? Michel Kalaf Yes. I mean I think maybe the key message here is that there would be no change. I think we've been very consistent in our approach, and New Frontier will not -- does not signal any change in that approach. As we've always said, again, I go back to deploying capital to its best and highest use. We want to continue to support organic growth. We are -- when we look at M&A, we look at it from a strategic fit perspective as well as it being accretive, clearing minimum adjusted hurdle rates, and we look at the types of opportunities that don't come with other baggage that are sort of a real set. And we compare those transactions to other potential use of capital. And then from excess capital belongs to shareholders, and we'd like to maintain also a healthy balance in terms of a growing dividend yield. And we've seen that also over a number of years, our dividend growing more or less in line with our earnings, I would say, adjusted earnings. And then I think also post the divestitures, we've been quite deliberate, expeditious in how we return capital. In terms of buyback. And if you look at the period '19 to '23, I think that speaks to that balance because we've deployed $17 billion in support of new business. We have about $14 billion in buybacks, over $7 billion in dividends, and we made $2.3 billion in acquisitions. So I think a very balanced approach and expect that to continue going forward. Ryan Krueger Great. Well, we're going to wrap it up there. Thanks to Michel and John and the MetLife team for attending, and we will wrap it up.
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OpenText, Wiley, Corning, and Digital Realty Trust discuss their strategies for growth and innovation during recent earnings calls and conferences. AI integration and cloud services emerge as key themes across the tech sector.
OpenText, a leader in information management, has reported strong growth driven by its cloud-first strategy and AI integration. During their recent earnings call, the company highlighted its focus on cloud services and the integration of artificial intelligence across its product portfolio 1.
CEO Mark J. Barrenechea emphasized the company's commitment to innovation, stating, "We are at the forefront of the AI revolution in information management." OpenText's cloud revenue has seen significant growth, indicating a successful transition to cloud-based services 2.
Wiley, a global leader in research and education, reported a strong first quarter with a particular emphasis on AI integration and cost-saving measures. The company's earnings call highlighted its strategic focus on leveraging AI to enhance its products and services in the education and research sectors 3.
Wiley's management discussed the potential of AI to revolutionize academic publishing and educational content delivery, positioning the company for future growth in an increasingly digital landscape.
Corning Incorporated, known for its expertise in specialty glass and ceramics, presented at Citi's 2024 Global TMT Conference, where it showcased its ongoing innovation in display technologies. The company emphasized its role in advancing technologies for smartphones, tablets, and automotive displays 4.
Corning's management highlighted the company's research and development efforts in creating more durable and energy-efficient display solutions, aligning with the growing demand for sustainable technologies in consumer electronics.
Digital Realty Trust, a leading provider of data center solutions, presented its growth strategy at Citi's 2024 Global TMT Conference. The company discussed its plans for expanding its global data center footprint to meet the increasing demand for cloud services and data storage 5.
Digital Realty's management emphasized the importance of strategic locations for their data centers and the role of energy-efficient technologies in their expansion plans. The company's focus on sustainability aligns with the growing emphasis on environmentally responsible practices in the tech industry.
Across these earnings calls and conference presentations, a common theme emerges: the increasing importance of AI integration and cloud services in the tech sector. Companies are investing heavily in these areas to drive innovation, improve efficiency, and create new revenue streams.
The focus on AI and cloud technologies reflects a broader industry trend towards digital transformation and the leveraging of advanced technologies to gain competitive advantages. As these companies continue to innovate and adapt, they are positioning themselves to capitalize on the growing demand for AI-powered solutions and cloud-based services in various sectors, from information management to education and data center operations.
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