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Operator: Hello, everyone, and thank you for joining us today for GBG First Half Results for Fiscal Year 2026. My name is Sammy, and I'll be coordinating your call today. [Operator Instructions] I'll now hand over to your host, Dev Dhiman, CEO, to begin. Please go ahead, Dev. Dev Dhiman: Good morning, everyone, and welcome to the GBG results announcement for the first half of fiscal year '26. We are pleased with the progress that we've delivered in the first half of the year, we're on track to meet our financial plan for FY '26, and we're confident in the acceleration that we'll see in the top line growth as we enter H2 and beyond. Whilst today is a chance for us to take you through the financial results, it's also a chance for us to remind you of the impact GBG has on the world at large in how we enable safe and rewarding digital lives for genuine people everywhere. The slide on the screen here speaks to that impact and the scale at which GBG operates. And I'm really proud of the mission that drives every one of Team GBG to show up and give more every day of the week. The statistics on this slide also serve to remind us all that the majority of the GBG business continues to perform strongly. However, we are very clear as to where the acceleration will come from, from here. 18 months ago, you heard me talk about the need for us to focus on 4 foundational areas. I'm really pleased with the progress we've made on each of these, whether that's in the way we've come together as a single global brand to remove complexity, whether that's how we've now recently signed to migrate our entire cloud to AWS to make sure we are globally aligned, whether that's the launch of GBG Go in April, driving our innovation agenda or whether that's the way we've rebalanced and reworked our entire performance frameworks for our people. We feel like a lot of the heavy lifting on these 4 areas are done, and therefore, our attention is now firmly turning towards driving shareholder value, in particular, through accelerating the top line. So how will we focus on creating shareholder value? We'll focus on 4 key areas. The first is around protecting and growing our amazing customer base. The second is about winning more new logos, more customers that need to work with GBG. Thirdly, we will unlock synergies in the GBG operating model. We've made some good progress on being globally aligned and removing complexity, but we think there's even more we can do, not just to drive efficiencies, but also to drive top line growth. And lastly, following a period of really hard work to get our balance sheet into a much stronger position, we'll talk about how we will optimize capital allocation. In my section, I'm going to focus on how we will drive revenue and unlock synergies. David will come back to talk about how we'll optimize capital allocation in his section. The good news is, underneath those key pillars, there are really only three things that matter. The first is how we complete the turnaround of our Americas business. The second is how we transition to the GBG Go platform. And the third is how we evolve our operating model to better serve customers, to innovate more quickly and to drive efficiencies that we can then redeploy into go-to-market. So let's start with, I'm sure what's on all of your minds, the Americas and where we're at with the turnaround. When I spoke to you 6 months ago, I talked about how we needed to strengthen the leadership team, execute the turnaround by driving productivity and focusing on metrics, evolve our commercial model away from pay-as-you-go towards subscriptions and commitments to lead with the GBG brand and to focus our teams on long-term growth and not distract them with short-term headaches. So where are we up to? So when it comes to our leadership team, in the first half of this year, we have appointed 6 new leaders. And it's important to stress those leaders come with deep industry experience. These are not people figuring out how to do this for the first time. Some of the measures that give us confidence that we're on pace for the turnaround. In the first half of this year, we have driven 4x more new business than we did in the first half of last year, and we're activating that new business more quickly with 28% faster in taking a deal from signature to go-live and ultimately when we start to earn revenue. In terms of our commercial model, standout progress with 8 renewals in the second quarter signed with a minimum commitment, almost the first time we've done that as a business. More encouragingly, as we look ahead, 74% of our upcoming renewal pipeline contains minimum commitment that's already been socialized with the customer. In terms of leading with the brand of GBG, you can see on the page a screenshot of the team at Money20/20, where we showed up as one team. That wasn't just Americas Identity. It was also the GBG Locate business showing up alongside our Americas Identity colleagues, really turning up as one business as GBG. And then lastly, as we focus on long-term growth, we took the decision this year to sunset a legacy platform, one that was creating significant distraction for the team and one that was never going to get our business to be a stronger underlying one, which is our complete intent as to how we focus on making decisions that drive the Americas business forward. Turning now to GBG Go and our transition to a platform business. At the end of FY '25 in our results presentation, you saw me demonstrate the benefits of Go for our customers. But today, I want to focus on the benefits of Go for GBG. We are confident that Go will increase the pace of our growth through the ability to win new customers. That momentum will build confidence in our teams and accelerate the opportunity to upgrade existing customers, driving cross-sell and upsell. Go is an adaptive platform. It's built for what's to come. It will meet evolving customer needs and drive advocacy and also improve NRR. From a technology perspective, Go enables us to rapidly innovate, build once and scale globally, releasing new capability to customers at the flick of a switch. The outcomes of our focus on Go will be accelerated growth, sustainable differentiation and a platform that unlocks efficiencies at GBG as we focus on 1 and not 16. And lastly, let me talk about how we will evolve and transform the GBG operating model. Really, there are three flavors to this initiative. The first is how we move to a functional organizational structure. Again, we've talked about the need for GBG to be simple and to align globally, and this is about taking that and ensuring it's embedded in our DNA. It enables us to ensure that we prioritize the key initiatives because we're now prioritizing across the whole portfolio and not by business unit or segment. And obviously, it reduces cost and duplication, which enables us to reinvest into our key initiatives, largely our go-to-market function. The second flavor of this initiative is how we innovate at a scale that we've not done before. By investing in a GBG-wide innovation system, we will deliver on the opportunity to combine all of the assets that we have in the GBG shop to create powerful new solutions for our customers. And lastly, this is also about driving improvements in our go-to-market. As a business, the majority of our revenue comes from about 15% of our customers. And we need to focus on those customers differently and treat them as GBG customers, not as identity or location or fraud. We believe our focus in this area is a meaningful revenue accelerator. And by increasing singular ownership of our largest accounts, we'll be hardwiring cross-sell into pay plans and the targets that we set to our salespeople, no longer relying on collaboration and lead sharing across teams. So what does all of that mean? It means that we are really clear on the three priorities that will make our boat go faster. And this is already turning into tangible benefits in the first half with more to come in H2 and beyond. So let's just give some of the key highlights. So driving the Americas turnaround. Year-to-date, we are on pace. We've got encouraging early proof points. I've spoken about those just now. And in the second half, you should expect the Americas business to return to growth by our continued focus on driving go-to-market execution and further improving some of the metrics I've spoken about. GBG Go and our transition to the platform. We launched the platform in April. We've had 18 new customer wins in the first half. And we've also integrated 200 digital identity schemes into the platform, which those 18 customers now have access to. In terms of what's ahead, we have a very strong sales pipeline, which we will execute in second half. From a capability standpoint, next on the road map is our no-code release and also really excitingly, our AI-driven insights module, unlocking synergies in the GBG operating model. In the first half, we have signposted a move to a global functional operating model. We have already combined our product and technology teams under single leadership, and we have created and funded the GBG innovation lab. In the second half, we'll continue the move to a functional model. The next phase is really focused on our go-to-market teams, and we'll continue to find efficiencies to reinvest in our key priorities. And lastly, how we'll optimize capital allocation. After a period of really hard work in getting our balance sheet into a much stronger place, GBG is now returning to optionality in how it deploys its free cash flow. In the first half of the year, we executed GBP 35 million in share buybacks, and we completed the first acquisition of this management team with the integration of DataTools in Australia, a business that we've worked closely with for a number of years and made huge sense strategically and financially. And as we look ahead to H2, this morning, we've announced a further GBP 10 million buyback as we continue to deploy our free cash flow to drive growth and shareholder returns. With that, I'm going to pass to David to take us through the financial results. David Ward: Thank you, Dev, and hello, and good morning, everyone. Thank you for joining us. I will now take you through a more detailed review of GBG's financial results for the 6-month period to the 30th of September 2025. We are pleased that the results we delivered in the first half of this financial year are in line with the plan that we built for this year and represent the operational progress that we are making towards an accelerating top line. We delivered revenue of GBP 135.5 million, which represents growth of 1.8% in constant currency terms. Setting aside two short-term impacts that were fully anticipated and which I will explain more shortly, constant currency growth on an underlying basis was 4.4%. This illustrates the improving momentum that we have already generated and which underpins our confidence in delivering a similar level of revenue growth in the second half of this year. Adjusted operating profit, also on a constant currency basis, increased 4.6% to GBP 29.5 million, reflecting our continuing cost control and profit margin control. Cash conversion remained strong at 85.8%, leading to a net debt-to-EBITDA ratio that remained below 1x at GBP 66.6 million. And demonstrating the Board's confidence in our plan, we have in FY '26, already before today committed a total of GBP 46 million in shareholder returns. And as Dev has already outlined, we have today announced a further GBP 10 million of share buyback. I can confirm that we are today reiterating our financial outlook for the full year, which is in line with consensus. So now let me provide an overview of the income statement here presented on an adjusted basis with the statutory format included as an appendix to this presentation. The headline is that we have maintained our strong control of margin, while at the same time, we have recycled cost savings from our ongoing transformation to a single global platform business into our growth-focused priorities, specifically for our largest segment of Identity. On a reported basis, revenue declined by 1% to GBP 135.5 million, but in constant currency terms increased by 1.8%. Our gross profit margin improved by 40 basis points over the prior year as we continue to focus on pricing as well as disciplined management of our data and cloud hosting costs. Adjusted operating expenses reduced by 1.5%. This too was impacted by FX translation. And on a constant currency basis, operating expenses increased by just 1.1%. That led to an adjusted operating profit of GBP 29.5 million, which represents an increase over the prior year of 4.6% in constant currency terms. As expected, our net finance costs decreased over the prior year as a result of the lower average level of net debt. And on tax, our effective adjusted tax rate for the period was 23%, which is a little lower than the 25% that we still expect for the full year due to accounting timing differences. As a result of the combination of the growth in adjusted operating profit, the reducing finance costs and tax charge, adjusted diluted earnings per share increased by 12.6% over the same period last year. As I said in my last presentation of our FY '25 full year results, we planned to continue with our business transformation initiatives and the costs associated with a few of the larger discrete items have been recognized as exceptional costs. These included the costs incurred in the period on our business systems unification and data insights projects as well as the costs of our move from AIM to the Main Market. The total cost recognized in the first half was GBP 3.6 million. Across the next two slides, I have more detail and analysis to explain the key dynamics behind our revenue performance. As I have already said, on a reported basis, revenue declined by 1% to GBP 135.5 million, but in constant currency terms, increased by 1.8%. That 1.8% was impacted by two short-term factors that we feel has somewhat masked the progress we have made in building greater momentum. The first of those two factors is the fully expected impact of high project-driven transaction volumes for Santander U.K. in the first half of FY '25. And the second is a decision we have taken to retire one of our legacy technology platforms as part of the Americas turnaround. As you can see from the bridge chart on this slide, without those impacts that both relate to our Identity segment, the underlying growth in the period was 4.4%. We feel it is important to share this sign that we have generated improved revenue momentum and also most importantly, because delivery of our plan for the full year assumes that we will continue to grow at approximately the same rate in H2, when there is no headwind from the Santander volumes and the headwind from the platform retirement is much smaller. My last comment on this slide is that we continue to enjoy a high proportion of repeatable revenue at 95% of our total. And we have a clear focus, as you have already heard from Dev, on increasing the 54% of that, which comprises subscription revenues. We now move to our rolling 12-month metrics and a reminder that these cover our two core segments of Identity and Location, covering 93% of the total group revenue. Global Fraud Solutions, our smallest segment, is excluded. It's pleasing to see the strong growth from new logo wins with this increasing to 4.1% for the last 12 months. This was assisted by a couple of larger wins with enterprise customers in the Location segment. We continue to see opportunity for us to maintain a growth rate of 3% to 4% from this factor, particularly as we make progress in closing the strong sales pipeline we have for GBG Go. Net revenue retention at the 30th of September was a little lower at 97.8%, but this was impacted by the short-term factors that I have already mentioned and which affected our identity growth rate. Excluding these, the trend for net revenue retention has been holding quite steady at around 100%. We continue to see improvement in net revenue retention as our largest opportunity for driving an overall growth rate improvement. And Dev has already outlined a number of initiatives that we are prioritizing to get net revenue retention back sustainably above 100%. Moving on to how each of our reporting segments performed. Identity, which represents 63% of total group revenue, grew 0.4% in constant currency terms and broadly maintained a consistent contribution margin. We generated strong growth in APAC and EMEA, although, of course, the EMEA growth was impacted by the unusually high Santander volumes in the prior year. While we had a small decline in revenue in Americas, we have been pleased with how the business is generally much more stabilized and gross retention has improved. The turnaround project has the highest level of focus and the momentum we carry into H2, together with the improved sales pipeline, we have confidence that this important component of our business will return to growth in the second half of the year. And Dev has already mentioned the encouraging early signs for GBG Go. Setting aside the two short-term factors that affected the first half and the comparative period from the last financial year, there is a trend for an improving growth rate in Identity. Location, which represents 30% of total group revenue, continues to be the main growth engine for the group with constant currency revenue growth of 4.8% in H1. That was despite some tariff-related softness in Q1. In terms of notable customer activity, we were pleased with our wins at Urban Outfitters and Alibaba and our scaled-up renewals at Shein and TalkTalk. Growth via our partner channel continues to be strong with customers like Oracle. And similarly, large enterprises like Microsoft are also recognizing the value of GBG's market-leading global addressing data for use in their own data quality processes. And finally, our smallest reporting segment of Global Fraud Solutions, which represents 7% of group. In this business, we are continuing to see very strong customer retention and subscription renewals, including the logos included on this slide. New business and the related implementation services has been a little bit weaker than a couple of years ago. And overall, we are reporting 1.4% growth. The contribution margin from the segment has expanded considerably as a result of the strategic review undertaken last year and which has led to some material cost reduction, which allowed investment to be redirected to our highest priorities of Americas go-to-market and the continued advancement of GBG Go. And then finally, and before I hand back to Dev for some closing remarks, a few comments on the balance sheet and capital allocation. As I said in our last year-end presentation back in June, with our debt leverage coming into this year comfortably below 1x EBITDA, we did feel that for the first time in a while, we had a greater degree of optionality on capital allocation. And so we have been proactive in utilizing that optionality to drive improved shareholder value. Firstly, of course, we paid the final dividend declared in respect of the previous financial year. And we have been continuing with our investments via exceptional items into our transformation initiatives and the costs of our move-up from AIM to the Main Market. We are confident that these initiatives will achieve strong returns for shareholders. We have also announced two share repurchase programs prior to today, the first ever in GBG's history. Those totaled GBP 35 million. Including the GBP 10 million that we have announced today, we have committed to share repurchases totaling GBP 45 million, with GBP 17 million of this completed in the first half of the year and a further GBP 28 million now committed to be completed by the end of the financial year. Given the share prices that we have been executing these programs at, we expect that in total, we will have repurchased approximately 7% of our issued share capital, and this should drive EPS accretion on a fully annualized basis of close to 4%. And finally, we were very pleased that we were able to add the DataTools business and team into the group. This was a financially attractive bolt-on opportunity to acquire a business that was known to us and which will add additional scale in a market where we are already seeing strong growth. Based on these capital allocation decisions that we have taken so far this year, we still currently expect to be able to exit this financial year with a net debt-to-EBITDA ratio of approximately 1x. With that, that concludes my section. Now back to you, Dev, for some closing remarks. Dev Dhiman: Thank you, David. So let's close out with a summary of some of the key messages you've heard today. 18 months ago, I said that GBG was a high-quality global business with scale, and that rings out even more truly today. I said we needed to focus on getting strong foundations in place for what was to come. And I think we've done a great job in getting that to a place where we can now turn our attention to driving acceleration of the top line. In the first half, we've shown exactly how we will deliver effective capital allocation through the buybacks and acquiring DataTools in Australia. And what you should really take away from this is that we have a very clear strategic direction, a direction that means that our focus on Americas, Go and our operating model will make the boat go faster. We have confidence in improving growth rates and those growth rates start to improve in the second half and beyond. Thank you all for your time, and we will now turn to questions. Operator: [Operator Instructions] Our first question comes from Andrew Ripper from Panmure Liberum. Andrew Ripper: I hope you can hear me okay. I got two questions, if that's okay. First question is for Dev. You counted through quite a few KPIs there, Dev, in relation to North American Identity. I wonder if you can tell us a little bit more about where you are winning, where the new leadership team is making a difference. And when you referenced that new bids have been 4x the level of the previous year, how significant is that in terms of being a delta on future revenue? Dev Dhiman: Thanks, Andrew. Sorry, we're waiting for your second one to come through at the same time. So I can take that. So I think as you said, we've seen some encouraging proof points as to where we're at with the Americas turnaround. And obviously, it is one of our three key focus areas, and we're putting a huge amount of effort and energy into making sure that we are on pace, which we feel like we are. I think in terms of some of those metrics, so 4x more new business, not only that, we're also activating that new business more quickly. You all know as a SaaS business, signing a deal is great, but then actually getting the customer live is as important, if not more. And we've seen encouraging progress on both of those. One of the reasons why we have won more new business kind of plays to your supporting question, which is we are focusing much more on where we win, and that's financial services, fintech and gaming. So almost all of that new business has come from those three verticals. And as a result, our win rate has ticked up. We've also seen in Americas where a customer has a more complex need and a larger order value, our win rate again increases. So we're getting much more analytical with Tom now at the helm and doing some of the things that he's done in former turnaround roles that he has performed. In terms of significance, it varies. A lot of those deals will be mid-market, but a couple of those, and we talked about price picks before, are more significant in terms of their revenue has until this year. Operator: Our next question comes from Nick Dempsey from Barclays. Nick Dempsey: I've got three, if that's possible. First of all, can you give us some more color on the initiatives that you have in place to get NRR back over 100%? And do you expect to be at least 100% in H2 2026? Second question, can you talk about the strength of your data relationships with the key credit bureau, Lexus, et cetera? Are you confident that you will have all of the existing data built into your offerings for many years to come? And is that starting to prove a real competitive advantage for retention and new logo wins? And then the third question, do you have any more legacy platforms, which could be in line for sunsetting, which could be a headwind at some point? Dev Dhiman: Thanks, Nick. I will maybe start with some of the color on the initiatives and then let David comment on the point around 100%. So I think we -- I think the good news is that, again, I'll just refer you to three key initiatives that drive NRR. The first is Americas, which has been a laggard in terms of revenue growth and therefore, NRR. And I think we've spoken already to Andrew's question and in the presentation around the work we're doing there. The second is Go, which we think obviously underpins our NRR because we moved to a licensed model versus consumption model. And obviously, we think the opportunity to drive cross-sell and upsell is significant. And the third is our operating model. You heard me talk in the presentation around how the majority of our revenue comes from, it's effectively an 80-20 rule, 80% of our revenue from 20% of our customers. And by focusing more on those 20%, I think that's where we see a big opportunity to upsell and cross-sell the whole breadth of GPG solution rather than treating them as a kind of divisional customer, if that makes sense. Maybe, David, you can talk about the kind of trajectory of NRR. David Ward: Nick, thanks for the question. I think a couple of points I'll just add to Dev's commentary there. I think the other point that I think came through in the presentation we just gave was also how we're now seeing the benefit of pricing coming through. That's been a really big focus for us for the last 18 months or so. And that's now much more embedded into everyday practice for our go-to-market team. So that's also having an impact for us. In terms of where do we expect it to get, we've talked that -- we've said previously that across the medium term, we do think that NRR should be able to get back to 105%, so that's our goal. That's probably a goal for a few years out. And we see sort of a relatively steady improvement towards that sort of number. For the second half, specifically, we will still have a bit of a headwind from the short-term factors I mentioned in the presentation. But I think the combination of what we're doing, plus particularly the improvement in gross retention in the Americas, which I talked about, I think should see us get back to 100% even before making any adjustment for Santander. Dev Dhiman: And then moving to your second question, Nick, around data relationships with bureaus or credit reporting agencies. I think the short answer is strong and strengthening. If, for example, for a couple of years now, we've been the only provider in the U.K. that has been able to have access to all three bureaus that operate here. Similarly, in ANZ, since Experian acquired Illion, we've now stepped in -- they have now stepped into our very close commercial relationship that we previously had with Illion and is now with Experian, and we've extended the length of that contract also in the first half. And in Americas, alongside everything you've heard me talk about, there's a lot going on, and therefore, we focused on the key things, but there's also work underway to drive data advantage and some early conversations with some of the people we've spoken about. So I think we feel like we're in a good place. Obviously, it's my background. For many years, we worked really closely with all three bureaus, large global bureaus as well as [Illion]. And it's an area where we continue to have a strong relationship and are talking about more what they could also take from us. And then the third question around legacy platform. So I think really important to remind everybody, we currently talk about having about 16. In the first half, we have taken the action to retire two. And those two are the ones that were most obvious to retire, the ones where revenue was going in the wrong direction and was not significant, but also cost was high and therefore, made them really easy decisions. The next 14 won't be as easy. And Nick, just to reassure you, what we're not saying is that as we retire those 14, we're going to see revenue go the wrong way. Our focus is on driving revenue growth, not shrinkage. And therefore, we're going to be really deliberate and mindful as to how we upgrade those customers to Go over the next 5 to 7 years. I think the good news in that is that there are operational efficiencies that, therefore, are not one-off, and we'll continue to see those over the midterm, and those will continue to help us drive reinvestment into our key priorities of Americas, Go and go-to-market. Operator: Our next question comes from Gautam Pillai from Peel Hunt. Gautam Pillai: I had a couple of questions on Go and to the comment you just mentioned, Dev. So when you migrate customers to Go, what is the typical level of recurring revenue uplift you're seeing per customer? And also beyond compliance and onboarding, what would you see are the differentiated capabilities of Go that kind of ensures pricing power and stickiness against competition? And one more follow-up on pricing generally, especially in the U.S., are you seeing customers push back on pricing at all? And how are the competition strategies kind of evolving from a discounting standpoint? Dev Dhiman: I can probably have a go at both of those and David, you can chip in. So I think on Go, Gautam, just important to remember that in the first half and probably for the rest of this year, our focus is on new business. We are not launching a migration of customers across. We have offered customers on the compliance platform the opportunity to move across, but -- so the answer to your question from a proof point standpoint is it's too early to say what the NRR uplift has been and will be. We think it's accretive to growth. But for right now, it's too early. The reason we think it's accretive to growth, though is your second question in that, which is the differentiated capability. So really Go moves us away from an onboarding solution into an insights platform. When we talked in the presentation about some of the things we're doing to get our data into better shape, it's also that we can deliver more insights to customers. So how are -- how is a gaming company performing in terms of its onboarding against its competitor set? What other things could we deploy into the workflow that will increase both the customer experience, making it better, but also increase the number of accepted customers and reduce fraud. So it's the analytics and the insights that we think will really differentiate us. We already have the underlying capability. So this really puts the icing on the cake is the way we think about it. And then on pricing, so I think a little bit linked back to the question around NRR. We're not waiting for Go to drive NRR. Some of the work we've done in the second quarter, in particular, in Americas to get 8 customers to renew with commitment has been driven partially through a pricing conversation. So a conversation that says, you've got the opportunity to defray price increases by signing up for commitment. The really good news is we have not had to give any of those 8 customers a haircut on price to get them to commit. It's the benefit of having someone that's done this for 20 years, Joe, who's joined our team to run our account management book, just driving best practice. We are also in Americas, launching pricing initiatives, especially around the long tail to see where we can see uplift. And those have not yet been launched, but the work that's underway, and we'll update you on those as we close out the year, I'm sure, in June. Operator: Our next question comes from Kai Korschelt from Canaccord. Kai Korschelt: I had a couple and just one is just to follow up on pricing, maybe more at an industry level. I mean it seems like there are a lot of players in the identity verification space. And I think previously, Dev mentioned that there's been sort of a downward trend on pricing. So I'm just wondering how do you plan to avoid commoditization, I guess, if that's the right word, and offset pricing pressure. It seems like Go is an important part of it, but just sort of more general, if you had any thoughts on a midterm basis, that would be helpful. And the second one was just around the capital allocation and specifically, how do you weigh, I guess, doing more share buybacks versus paying down debt as you also get accretion from lower interest cost as you've obviously shown in the half. Dev Dhiman: Thanks, Kai. So I'll take the pricing one and David maybe can chip in on the capital allocation. I think it's really important. It's another good example and an opportunity for me to remind everybody that the majority of our business, we have been really successful in maintaining and increasing price, be that the identity business in APAC, EMEA or the Location business worldwide. So really, where we've had -- where we've suffered on NRR has been Americas and part of that has been the commercial model, which has been pay-as-you-go. We think about pricing as a growth lever. We've demonstrated that, as I said, in most of our businesses, and we'll shortly be testing that in Americas. The ability for us to move customers to minimum commit underpins my confidence. And what else underpins my confidence is the fact that the majority of our industry is pricing in that way. So in Americas only, we are catching up. The point around commoditization, I think you kind of answered your own question, Kai, Go is what we think will differentiate us, in particular, the move to an insights-driven platform rather than a point in time tick in the box, which is never what we were, but I think that's kind of the underlying question that you have in the question that you've asked. And maybe, David, on capital allocation. David Ward: I'll pick up the question on capital allocation. I think we feel good that we've got much more optionality than we've had for a few years now. I think it's been great coming into this year with a level of debt below 1x. As I outlined in the presentation, the actions we've already taken and the decisions we've announced will probably mean that we exit this year at about 1x EBITDA to net debt leverage, which I think we feel very comfortable with. And obviously, at the moment, very aware of where the share price is at and particularly versus the level of interest costs that we've got on our debt, buying back shares is attractive for us at the moment. I mentioned in my presentation that based on what we've announced in terms of share buybacks, based on our forecasting assumptions, we expect about 4% accretion to EPS on a fully annualized basis. So that's pretty attractive. At the same time, it's been great that we've been able to execute our first acquisition in a while to be able to add a relatively small bolt-on business, but actually a business that gives us a bit more scale in a market that was already enjoying good growth. So we've added a business that was growing. It has got good profit margins, and we've added some very capable team members in a region that's important to us. I think it is also attractive. So it's great to have sort of that full range of options around how we deploy capital. But I guess the punchline is we are very focused on delivering improved returns for shareholders, and we will deploy capital in the best way to be able to do that. Operator: Our next question comes from Julian Yates from Investec. Julian Yates: I'd just like to dig a little bit more into the North America business versus EMEA to try and understand where we are in the upside. Do you have any color on sort of return on investment metrics? Like what is EMEA doing in terms of revenue per sales, head revenue per account, return on investment versus what North America is doing at the moment? And when -- and can North America move up to those sort of EMEA levels? Is there quite a lot of upside to go? And then on the flip, is it just massively underinvested in [indiscernible] the fact that there's going to be a cost taker for a couple of years before we see maybe sort of margins or [indiscernible] move up to that EMEA level? David Ward: Julian, it's David. So I'll have a go answering that one for you. And I think the first thing I would say is that the turnaround that we are executing in Americas actually looks very similar to the process that we went through for EMEA a couple of years ago. So there are great similarities, which, to be honest, is very helpful for us and obviously means that some of the expertise that we have in the EMEA team has been really helpful to the Americas team as well as the new capability and stronger team that we've deployed into that region. So I think there are some similarities. I think the way we think about the Americas business -- has been that we have had to strengthen the team that we have deployed there. We've talked about all of the actions that we've done to do that. We've also given them increased and better tools. So they've got better internal tools. They've got better support from the enabling functions. And at the same time, we are -- we've talked about unifying our back-office systems and CRM tools. So all of those things we have done, and we are almost through finishing. So that gives us a really solid foundation. Dev has talked about the fact that relative to our EMEA team, the Americas team is under resourced, but we've always felt that we needed to solidify those foundations first. And once we've done that, there is a really good opportunity for us to then enjoy the benefits of economies of scale as we employ and deploy more salespeople into the region. So I think that's how we think about it. I'm not sure I'd necessarily agree that it's going to be a cost taker. I think that was the phrase you used. I think we see that it's a business that should scale relatively well from here. We do want to deploy more cost into the region, but we expect pretty constant and relatively quick returns on that cost. So I think from here on in, we expect the opportunity for margin improvement for Americas. It will be relatively modest as we put the cost in there. And obviously, there's the benefits of Go to still add on top of that. So I think there's a number of things that we're pretty excited about. Operator: Our next question comes from Tintin Stormont from Deutsche Numis. Tintin Stormont: Just -- I think it's two questions, maybe three. The first one is the quality of the pipeline. Is there anything that sort of a sense that you could give us that obviously, there's the volume and the actual increase in the pipeline. But when you're trying to convey to us a sense of the improved quality of the pipeline, is there anything that you can share in that regard? And then, David, just picking up on your point on resourcing in the U.S., where are we in terms of the resourcing? And how easy is to find that additional resource in the market and for them to sort of kind of have the impact that you want them to have? And finally, from a competition standpoint, if you could just maybe describe sort of kind of in the environment if there are particular players that you're winning against with the GBG Go product? And sort of kind of -- I think, Dev, you talked about the features that are differentiating you, but would be really interested in that, the areas that you choose to play in, FS, gaming, fintech, et cetera, if there are particular competitors that seem to be relatively losing out to you now with this platform? Dev Dhiman: I think all 3 probably for me, Tintin. So in terms of quality of pipeline, so I think, again, we don't really disclose volume of pipeline. I think we talked about the number of Go opportunities specifically, but our pipeline is obviously much broader than that. I think what I can say is I think there are a handful of key opportunities that I'm very close to that feels a bit different maybe this time last year. So I won't say any more than that because I'm breaking my own cardinal rule to not talk about those. In terms of resourcing in Americas, I think, as I said in my presentation, we've hired 6 new leaders have all come from this space. It has not been difficult to find people that, number one, have deep industry experience, and it's not been difficult to find people who want to be part of the GBG story. I think what's been encouraging is how we've seen many of those 6 leaders bring in people from their network. That's interesting to me for two reasons. One, I think we've hired the right people if they know people. But secondly, the fact they're bringing people in that they trust and trust them means that their commitment to the cause and their ability to see the end of the turnaround and the start of acceleration is quite high. So open rates in the Americas, I think we measure them in days, not months. And then lastly, on competition, I'm going to answer this slightly differently. I think we're focused on ourselves and maybe that's also a bit different to a year ago. I think we're focused on how we stand out from our competitors. And I'd rather talk about what we're doing than what we're seeing in the market. Again, a good chance for me to remind everybody that for many years now, we've won against our competitors in location. We've won against our competitors in EMEA, and that's getting increasingly so, I would say. And in APAC, for a number of years, we continue to have a really strong market share in ANZ that should only get stronger with the integration of DataTools. So yes, hopefully, that answers your questions. Operator: We have no further questions. Dev Dhiman: Yes, I think that brings us to the end of questions. So thank you, everyone, for your time and for the questions. I will just close with a few short comments that really reiterate what I said at the end of the presentation as it was. I think a good chance for us to always take the opportunity to remind everybody what a great business this is that operates in a really fast-growing space that is only getting more interesting and the scale that we enjoyed. Good to be able to stop now talking, hopefully, in these presentations around the 4 focus areas that we set out on back in June of last year, although albeit our work is kind of never done on those. I think what you have heard today is really two things, a very effective and deliberate capital allocation that is all about driving increased shareholder returns and a very clear strategic direction that really means that you'll only really hear me talk about three things: Americas, GBG Go and our operating model, all of which gives David and myself and the Board confidence in improving growth rates, which, as I said in the presentation, start now. Thank you all for your time, and have a great rest of the day and week.
Operator: Good day, and thank you for standing by. Welcome to Ambarella's Third Quarter Fiscal Year 2026 Earnings Conference Call. At this time, all participants are in a listen-only mode. After the speakers' presentation, we will open up the call for questions. To ask a question during the session, you will need to press 11 on your telephone. You will then hear an automated message advising your hand is raised. To withdraw your question, please press 11 again. Please be advised that today's call is being recorded. I would now like to hand the call over to your speaker, Luisa Hardy, Vice President, Corporate Development. Please go ahead. Luisa Hardy: Thank you, Victor. Good afternoon, and thank you for joining our third quarter fiscal year 2026 financial results conference call. On the call with me today is Dr. Fermi Wang, President and CEO, and John Young, CFO. The primary purpose of today's call is to provide you with information regarding the results for our third quarter fiscal year 2026. The discussions today and the responses to your questions will contain forward-looking statements regarding our projected financial results, financial prospects, market growth, and demand for our solutions, among other things. These statements are based on currently available information and are subject to risks, uncertainties, and assumptions. Should any of these risks or uncertainties materialize, or should our assumptions prove to be incorrect, our actual results could differ materially from these forward-looking statements. We are under no obligation to update these statements. These risks, uncertainties, and assumptions, as well as other information on potential risks that could affect our financial results, are more fully described in the documents we file with the SEC. Before starting the call, we hope to see you at one of the following investor events that we have scheduled during the fourth quarter. In December, we will be at the UBS Global Technology and AI Conference in Scottsdale, and in December at Nasdaq's London Conference. On January 6, from 4 to 5:30 PM at our CES location, we will be hosting a technology and product briefing. In January, we will be hosting more than a dozen sell-side analysts tours of our CES demonstrations, again at our CES location in Las Vegas. On January 17, at the Needham Conference in New York. Access to our third quarter fiscal year 2026 results press release, transcripts, historical results, SEC filings, and a replay of today's call can be found on the Investor Relations page of our website. The content of today's call, as well as the materials posted on our website, are Ambarella's property and cannot be reproduced or transcribed without our prior written consent. Fermi will now provide a business update for the quarter. John will review the financial results, and then we will be available for your questions. Fermi? Fermi Wang: Thank you, Luisa. Good afternoon, and thank you for joining our call today. Before we proceed, I want to let you know that last call, our co-founder and CTO, will be stepping down from the board of directors to become our chief technology adviser. He will continue to oversee our technology direction and development but without management responsibilities, and with user time commitments. Les and I have worked closely since 1994 across four companies. I am grateful that Les will continue as my close partner for over thirty-one years and beyond. He is truly the best I could wish for. I am happy he will have more time to pursue his passions, but I will definitely miss our daily conversations on various topics. Turning to our fiscal third quarter, we are reporting another strong quarter with both revenue and non-GAAP EPS exceeding expectations. We achieved record quarterly revenue of $108.5 million, slightly above the high end of our guidance range. Edge AI, which we define as a product that integrates one of our proprietary deep learning AI accelerators, was about 80% of our total revenue, representing our sixth consecutive quarter of record Edge AI revenue. We have increased our fiscal 2026 revenue guidance, which projects an all-time fiscal year total revenue record for Ambarella. With the strength in our average selling price and the breadth of demand, we are raising our fiscal 2026 revenue growth guidance to a range of 36% to 38%, or approximately $390 million at midpoint. This compares with our prior estimate provided on August 28 for 31% to 35% year-over-year growth, or approximately $379 million at midpoint. These results are very encouraging, but I am even more excited about the Edge AI activity ahead of us. There are three key factors behind our enthusiasm and our strong commitment to Edge AI. First, the breadth of applications demanding Edge AI technology in our product is expanding. Second, the AI performance requirement for our product roadmap is expected to continue to rise, driving robust new product cycles. Third, our ASP has been increasing, and in the long run, we continue to see an excellent opportunity to capture more value per design. I will elaborate on those points. First, AI at the edge is becoming more prevalent, driving an increasing breadth of applications in both enterprise and consumer-driven parts. Our Edge AI business started in enterprise security, followed by automotive safety, smart home, and telematics. More recently, the portable video market, which includes action cameras, panorama cameras, and body-worn cameras. Looking ahead, high-value shipments into the aerial drone market are expected to commence this quarter, representing just the beginning of our realization of the large robotic market opportunity. There is also strong interest from existing and new customers in our Edge infrastructure part and roadmaps, and we are committed to developing this incremental opportunity. In addition, ADAS and the vehicle economy remain large markets that can leverage our technology to a very high degree. Second, we see a large opportunity to execute at the edge with increasingly complex AI technologies currently implemented at the core of the network or in the data center. The challenge and our opportunity is that the solutions used in the network are often not suitable for the edge. With edge performance requirements rising, in each market, low power consumption, real-time processing, privacy, security, small form factors, thermal, network bandwidth efficiency, and lower price points are critical. At Ambarella, we continue to invest heavily in our proprietary Edge AI SoC technology and products to support these unique and increasing AI requirements. For example, our 10-nanometer CV2 family supports CNN networks, and our 5-nanometer embedding our third-generation AI processors is scaling our customers into more complex CNN and generative AI applications simultaneously. Third, we see an excellent opportunity to continue to increase our ASP. The shift from CPU workload to high-level over-accelerated computing or AI is well underway. The adoption of increasingly complex data center technology for the edge is another driver. Finally, the extension of our roadmap to other edge endpoints and into the edge infrastructure and auto economy is also expected, in particular, to boost our ASP. For example, our SoC branded ASP in Q3 was up about 20% year-over-year, and as our third-generation AI SoCs and other new products become a more material portion of our revenue, we anticipate further increases in the value we earn per design wins. I will now describe some of the representative customer engagements that reflect the factors I just described. In the enterprise security market, we are very pleased to share a significant milestone with our customer, Sparsh, who became India's first security camera manufacturer to receive STQC certification for its complete range. At the heart of the collaboration is our CV28. This gives us a tremendous start to accelerate our adoption in a rapidly growing "Made in India" market. Infinity, spun out of Bosch, announced their Autodome 7100i moving PTZ camera with built-in AI analytics and Ultra HD image based on CV72. They have also announced their diamond thermal security camera is based on CV22. It runs their CNN models to detect and classify objects accurately up to 2,000 feet. WCADA announced their upcoming CV75-based AM64 Access Station Pro, which enables secure physical access with AI facial recognition, touchless face unlock alongside traditional badge and mobile access methods. The company also launched a new CR63E remote security camera that leverages the power efficiency of our CV75. They also expect the CV72-based multi-sensor security camera product line, including CH53, CH63, and CY63. Motorola has developed their additional Halo 4 smart sensor on our CV25, which is an all-in-one environmental monitoring and security device that is designed for areas where cameras are restricted to detect events like smoke, fire, and audio anomalies. In the robotic and smart home market, one of our customers, Whiskers, announced the Litter-Robot 5 Pro, their first model with facial recognition and 4K night vision clip AI-powered camera based on CV28. We are seeing great momentum in our portable video market with Arash, who released two models this quarter. The X4 AIR, at just $165, is a new lightest compact 8K 360 action camera based on CV5. It is the first in a range to support 8K 30 frames per second active HDR. Arash also launched the latest version of their body-worn camera, Go Ultra, based on CV52. It captures 4K 60 frames per second video and a 50-megapixel photo with improved performance in low-light environments. In our automotive safety, ADAS, and telematics business, I would like to share some key customer wins during the quarter. Zika, a unit of GD, has evolved their in-cabin DVR system CV28 for the NIO ES8 full-size luxury model. Xiaopeng expands their global market presence. They have built all their driver management systems for all their export models on CV28. Solara, a global leader of vehicle lifecycle management, announced their new AI-powered smart camera, October, based on our CV22. In a first for Solara, the ASR5 is powered by AI plus human input intelligence, a revolutionary approach in fleet analytics that combines AI-based analysis with human oversight to improve safety, efficiency, and operations. From these representative customer engagements I just described, the strength of our current product portfolio is clearly represented. With every example from the 10-nanometer CV2 family and seven examples from our 5-nanometer generation, these products, all available today, offer customers a wide variety of options ranging from CNN to transformer network processing, one to many sensor input support, multiple sensing modalities, all at a wide range of price points. Our new product roadmap will expand this portfolio further. In addition to our comprehensive and expanding AI SoC portfolio, another important distinguishing characteristic of our portfolio is the advanced technology we offer to customers at the edge. For example, 5-nanometer-based products represent more than 45% of our total Q3 revenue, with products based on more advanced nodes in development. In summary, the first three quarters of fiscal 2026 are steps in the right direction with strong revenue growth, new product execution, profitability, and with our cumulative year-to-date free cash flow almost 14.8%. We continue to have a large edge serviceable available market over $12.9 billion by fiscal year 2031. In the early innings, we recognize the TAM market is still developing, and to successfully address this large set, we remain highly committed to our R&D investment that enables us to build upon our existing leadership position. I hope to see you on January 6 at our CES 2026 product and technology briefing, which will give you a chance to learn about new technologies and products and meet a full set of our management team. With that, John will now discuss the Q3 results and the Q4 outlook. John Young: Thanks, Fermi. I'll now review the financial highlights for the 2026 ending October 31, 2025. I will also provide a financial outlook for our 2026 ending January 31, 2026. I'll be discussing non-GAAP results and ask that you refer to today's press release for a detailed reconciliation of GAAP to non-GAAP results. For non-GAAP reporting, we have eliminated stock-based compensation and acquisition-related expenses adjusted for the impact of taxes. For fiscal Q3, revenue was $108.5 million, above the high end of our guidance range of $100 to $108 million, up 13.5% from the prior quarter and up 31.2% year-over-year. Sequentially, automotive revenue increased in the low single digits, and IoT increased in the mid-teens, with IoT growth led by the adoption of Edge AI in enterprise security and portable video applications. Non-GAAP gross margin for fiscal Q3 was 60.9%, slightly above the midpoint of our prior guidance range of 60% to 61.5%. Due to product mix, non-GAAP operating expense in Q3 was $55.3 million, slightly below the midpoint of our prior guidance range of $54 million to $57 million. Q3 net interest and other income was $2.1 million. Q3 non-GAAP tax provision was $900,000. We reported a non-GAAP net profit of $11.9 million or $0.27 per diluted share in Q3. Now I will turn to our balance sheet and cash flow. Fiscal Q3 cash and marketable securities reached $295.3 million, increasing $34.1 million from the prior quarter and $68.8 million from the same quarter a year ago. Increased cash and marketable securities primarily from operating cash flow associated with increased revenue. Receivables days sales outstanding decreased from forty-one days in the prior quarter to thirty-six days. And days of inventory decreased from eighty-five to seventy-six days. Operating cash inflow was $34.3 million for the quarter. Capital expenditures for tangible and intangible assets were $2.9 million for the quarter. Free cash flow was $31.4 million. We had one logistics company representing 10% or more of our revenue. WT Microelectronics, a fulfillment partner in Taiwan, that ships to multiple customers in Asia, came in at 70.2% of revenue for the third quarter. I will now discuss the outlook for the 2026. The breadth of our Edge AI business is expanding. Together with strong unit volume and average selling prices, as a result, in Q4, we forecast revenue in the range of $97 million to $103 million, or $100 million at the midpoint. With a higher percentage of revenue coming from our high-volume customers. Sequentially, due to seasonality, we expect a mid to high single-digit decline in both our automotive and IoT businesses. We expect fiscal Q4 non-GAAP gross margin to be in the range of 59% to 60.5%. We expect non-GAAP OpEx in the fourth quarter to be in the range of $55 million to $58 million, with the increase compared to Q3 driven primarily by employee-related and CES expenses. We estimate net interest and other income to be approximately $2 million, our non-GAAP tax expense to be approximately $600,000, and our diluted share count to be approximately 44.5 million shares. Thank you for joining our call today. And with that, I'll turn the call over to the operator for questions. Operator: Thank you. And at this time, we'll conduct a question and answer session. As a reminder, to ask a question, you will need to press 11 on your telephone and wait for your name to be announced. To withdraw your question, please press 11 again. Limit yourself to one question and one follow-up in the interest of time. Please stand by while we compile the Q&A roster. One moment for our first question. Our first question will come from the line of Tore Svanberg from Stifel. Your line is open. Tore Svanberg: Yes. Thank you, and congrats on another record quarter. As my first question, when we think about that, let's call it, 36% to 38% growth for fiscal 2026, how much of that is unit versus ASP because, you know, obviously, you know, Edge AI now is becoming a pretty high percentage, but even within Edge AI, obviously, you have ASP increases. So just trying to understand how much of the growth has been driven by ASP versus units. Fermi Wang: Right. So I think both of them contribute to our growth. I will say I don't have the exact number. If I have to guess, it's probably half and half. I think our unit growth definitely continues to contribute from the Edge AI side. But ASP growth is also significant, as we talked about in the script. So I think that both of them contribute to our end results. Tore Svanberg: Yeah. Thank you, Fermi. That's very helpful. And as my follow-up, you talked about the portable video market. Could you just add some more color there? I mean, it sounds like you have some new design wins. These are obviously AI-based drones. But, just you know, I know you've been in that market for a while, and, obviously, that market sort of faded. And now it seems to be coming back. So how should we just think about that market driving growth for Ambarella going forward? Thank you. Fermi Wang: Right. You talked about portable and multiple different product lines there. I want to be a little bit more specific. In fact, we talk about action sports cameras that you said we have been here for many years. And the new category is panorama cameras that Arash is famous for. And also, we talk about drones, which are also part of the portable video. But in addition to that, our wearable cameras, web cameras, video conferencing products, all of them are part of the portable device because that's where our customers are focusing on. So overall, that's an area that is providing a big portion of our growth this year. And we believe that this market is going to continue to grow. And in fact, I have to say that I'm a little surprised by the size of the market that has grown over the year. But definitely, the momentum is there. Our job is trying to not only secure our market share but hopefully grow some market share in the future. Luisa Hardy: Hey, Tore. It's Luisa. Just technically, we call it portable video and other. So there's a lot of things in there, as Fermi said. Tore Svanberg: Yeah. Thank you for that. Congrats again. Fermi Wang: Thank you. Operator: Thank you. One moment for our next question. Our next question will come from the line of Ross Seymore from Deutsche Bank. Your line is open. Ross Seymore: Hi, guys. Thanks for asking a couple of questions, and congrats to Les. I guess, first, you talked about the breadth of your business in the Edge IoT side of things or Edge AI, IoT, whatever you guys are calling it now. Can you just talk a little bit about the consumer versus kind of the enterprise side? Now, I guess where I'm going is the portable side is great. But we've seen volatility around any sort of consumer applications in years past. Cycles past. I just wondered how you're managing that in this instance. Luisa Hardy: Hey, Ross. It's Luisa. The split is roughly fifty-fifty, 50% kind of enterprise CapEx driven and 50% consumer. And then within that 50% that's consumer, you've got some kind of consumer durable things like, say, smart home cameras that get replaced every five or six years. But then you also have consumer discretionary, which I think is some of the more volatile things you were referring to. So it's pretty evenly split at the highest level between the CapEx driven markets and the consumer, but different types of consumer spending. Ross Seymore: And I guess one for John. How are we thinking about gross margin as we look into next year? Just conceptually what the pluses and minuses would be? I know you have the long-term target of the 59% to 62%. You're a little closer to the lower end of that in your fourth-quarter guide. But just running through any of the puts and takes would be helpful. John Young: Yeah, Ross. Thanks. So as you said, our long-term model is 59 to 62. And as we said in our Q4 guide, the composition of gross margin really depends on the contribution of, like, our high-cost customers. So, you know, whatever the gross margin is from quarter to quarter, that's at least in the near term, that's a primary driver. Ross Seymore: Great. Thank you. John Young: Yep. Operator: Thank you. One moment for our next question. Our next question comes from the line of Joe Moore from Morgan Stanley. Your line is open. Joe Moore: Yeah. Great. Thank you. I also wanted to ask about that gross margin target. And I guess just as you've kind of refocused the business around a lot of exciting opportunities, you know, is there any chance to really fully participate in some of the consumer markets that you might accept lower gross margin in exchange for growth? And then I guess you've talked a lot on this call about average selling price sort of what's driving that focus, you know, as ASP versus, you know, kind of gross profit dollar per device, things like that? John Young: Yeah. Thanks. So, you know, as far as the ASP goes, that is primarily a function of the technology and features that come with these more advanced technology tape-outs that we're doing and products that we're developing on our roadmap. As far as the gross margin goes, you know, like I said, 59 to 62. I think as far as consumer, on a case-by-case basis, depending on the volume that we see, the opportunities that we see, we're not opposed to gross margins that are maybe not strictly within the 59 to 62% range. But the goal at the corporate level is to, over the long term, stay in that range. Joe Moore: Great. Thank you for that. Then I guess, you know, yeah, there's a lot of enthusiasm for drones, which is a market that you've kind of been in in the past. Can you talk about, you know, what are the new elements of that market that probably, you know, might drive you to a higher content over time? You know? And what is it sort of think about delivery drones and industrial drones and things like that? Is that a pretty big category for you down the road? Fermi Wang: Right. So first of all, we were big in the past, as you said, but we were stopped in that market because of the geopolitical situation, not because of our technology solutions. And this time we came back because we continue to believe a few things. First of all, there was a dominant player, but in the US, the market is wide open at this point for everybody to fight in that capacity. So with our video technology, particularly our panorama camera that we help our customers to build, is well suited for this space. So first of all, the driver for us is to continue to provide the best video solution in the drone market. But more importantly, I think moving forward, all the drones are going to be autonomous in the future. We can't talk, say, today's drone is level two. And level three, level four drones are coming and probably going to drive faster than autonomous driving cars. And we believe that to have a level three drone, it will require a really powerful chip in addition to the video processing, and that's really played to our strength also. Our investment in autonomous driving directly applies here. So from the technology point of view, the video processing plus AI is the key driver. But as you said, today, the biggest market opportunity for us is consumer for video capture, but moving forward, we start seeing opportunities on the commercial side, which is going to continue to drive growth. So we are excited that, first of all, we have technology that we think is differentiated in this market, but more importantly, the service market for us is growing fast. So that's the two reasons that we feel excited about this market. Joe Moore: Okay. Thank you. Operator: Thank you. One moment. Our next question will come from the line of Christopher Rolland from Susquehanna. Your line is open. Christopher Rolland: Hey, guys. Thanks for the question and congrats on the results. I guess my first question is around an update perhaps for the infrastructure opportunity and the N1655? Fermi Wang: Yeah. So first of all, we announced our first design wins last quarter. And after that, we continue to see very strong design win activity and interest from different types of customers. In fact, in the last few months, we see customers who want to use video-centric products and also customers who want to use N1655 for non-video-centric products. So we are seeing a wide range of opportunities. And we are also continuing to see our chance to not only build up but also bring new designs in the near future. So we are totally committed to this market with N1655 and a new roadmap that we will talk about in the near future. Christopher Rolland: Thank you, Fermi. And perhaps if there are any updates on two other opportunities, I guess the first would be the home security market with, you know, AI feature integration. And then the second would be any kind of design activity, I know it's further out, but around humanoid robots. I think that would be interesting as well. Fermi Wang: Right. So first of all, for the home security, I think we do have design wins with our CV75 that we haven't announced yet, but definitely is in design. However, I think this is a market that's price-sensitive. So I think the progress or the movement towards this chain AI type of home security camera based on the camera solution, not the cloud solution. We really focus on just edge AI for this market. So with that, I think that market is not developing as fast as we expect, but we do have design wins. We hope we can talk about them sometime next year. From the humanoid robot perspective, I think this is a long-term market that we definitely want to participate in. However, I think it will take time to get to a humanoid robot. I think there are multiple steps for robotic from today's situation to the humanoid robot. And I think, like I said, even drones, if you treat the drone like a robotic application, there's a level two to level five. I think humanoid robots are level five of drones for different applications. But there are intermediate steps we need to go through, and we definitely have design wins and also design activities in those steps that will lead us into the humanoid. I just want to be more specific. We're offering two types of solutions to the robotics today. One is for people only interested in the video technology. So they want to have a really powerful AI that not only can see the object but also can do object detection based on CNN networks. We have that kind of solution based on our CV2 family or CV72, CV75 solutions. So that's one product line we're providing. The other product line we're providing to the robots is really a brain. Right? So our N1655 type of solution can be a central processor for any type of robotic out layer. So I think we're offering these two solutions. It will take time to develop a central domain control, like an autonomous driving car, that kind of solution will be required to do a humanoid solution in the future. Christopher Rolland: Excellent. Thanks so much. Operator: One moment for our next question. Our next question will come from the line of Suji Desilva from Roth Capital. Your line is open. Suji Desilva: Don, Les, best of luck with the step of your transition here. So, maybe in the Edge AI market, looking ahead, calendar '26 perhaps, which of the two or three segments would you describe as the highest kind of growth opportunity for you? Is it drones or other areas? Any color there would be helpful. Thanks. Fermi Wang: I think drones definitely, what you call out, are going to be a growth area for us. And I also believe that even for the edge endpoints, we continue to see multiple opportunities coming up with different types of products. For example, wearable cameras, we talked about this for many years. But right now, we are excited because wearable cameras are not only for policemen anymore. We start seeing that go to totally even for commercial use devices. So that's just another example that the technology becomes ready in a low power and also AI on the camera. All of that enables a new application for wearable cameras. That's another really high growth area that we're seeing, and it's not only what I'm saying that if you follow our customers, you'll see that our customers are saying similar things. So those edge endpoints, families, are the first area for us. But I also want to bring your attention to the edge infrastructure. We'll talk about it last quarter. I think although that not immediately, you're going to see high revenue growth, but I think long term, that will be a very important market for us. And we'll definitely cover insight into our plan, our thoughts on edge infrastructure at CES and give you more. Suji Desilva: Okay. Great. Then for me, in one specific question on drones, do you have any visibility in your pipeline beyond consumer commercial perhaps into any government programs? Or is that going to be a separate part of the market handling that versus you guys? Fermi Wang: You bet the old customer fact, it's not really us. It's all cost. All cost. Right. Right. No. I think all the customers have a desire to serve multiple different market segments. But most of them, most of our common customers, are focusing on consumer commercial, and I don't think that algorithm usage is a real focus for most of our customers yet. Suji Desilva: Okay. Great. Thanks, Fermi. Operator: Thank you. One moment for our next question. Our next question will come from the line of Martin Yang from OpCo. Your line is open. Martin Yang: Hi. Thank you for taking my question. First question on IoT, especially with growing customers like Arash, could you maybe comment on this customer's growth and its relative contribution to your overall ASP and margins? Fermi Wang: Right. So first of all, Arash is, I think, the largest customer in our top 10 list, and they're ramping roughly doubled from last year to this year. But, you know, they are using multiple chips, and if selling to multiple OEMs, it's hard for us to track exactly their revenue contribution. But we have no doubt they are the largest customer right now. Martin Yang: Thank you. Another question on drones. So when you're referring to next year's product, are those drones using your image processing capabilities, or do you expect them to deploy AI functions that relate to autonomous flying capabilities? Fermi Wang: Both. I think that, like I said, there are two types of solutions we're offering. Some of them are using just video plus AI to apply CNN-type networks for simpler AI functions. But there will definitely be customers using our AI for flying to avoid objects, to determine the flying path. So both of them. Martin Yang: Got it. Thank you, Fermi. That's it for me. Operator: Thank you. And our next one moment for our next question. Our next question will come from the line of Quinn Bolton from Needham and Company. Your line is open. Quinn Bolton: Hey, guys. I know the focus has sort of shifted to Edge AI in the future, Edge infrastructure. But in the past, you gave us sort of an automotive funnel. You haven't provided that. So just wondering how should we be thinking about how are you guys approaching the automotive market? Do you still see opportunities in Level 2 plus, or are you kind of deemphasizing some of the automotive applications? Fermi Wang: Alright. Thank you for that question because we did not decommit from that market. In fact, we continue to focus on the market. We are engaging multiple OEM tier ones at this point for autonomous driving level two, level two plus, some even level three. So from the engineering activity and business development activity point of view, we are all in on this market. Definitely, from the funnel of this discussion point of view, I said last quarter, we will provide a funnel discussion in the next quarter release. But the one modification I will do, we are stopping using probability-weighted metrics. We are going to give you just direct opportunities we're looking at. So that will be the one change we're going to offer, but we will definitely provide more guidance on how we look at this market. Quinn Bolton: Got it. Thanks for that, Fermi. And then I guess for John, just you mentioned that it sounds like the mix towards high-volume customers is pushing the gross margin down to the lower half of your long-term range. Can you give us just beyond January? Do you think that mix continues to be pretty heavy with higher volume customers? Or do you see this as sort of a temporary shift just for January and it normalizes beyond that? John Young: Thanks, Quinn. Yeah. At this point, we don't want to give a guide with regard beyond Q4. But I think, you know, that commentary with regard to Q4 is, you know, will continue to be relevant going forward. The ratio of high-volume customers to the total revenue for the quarter. Quinn Bolton: Sorry, John, cut out there a little bit. Did you say that the mix would stay pretty similar beyond January? John Young: No. What I tried to say was that, you know, we don't want to make any guide beyond Q4. But that the commentary about Q4 with high, you know, the ratio of high-volume customers to the total revenue, that dynamic will continue to be a factor going forward. So to the extent that the high-volume folks are a higher percentage of the revenue, that will, you know, have its impact. Quinn Bolton: Got it. Okay. Thank you. Operator: Thank you. And once again, that's star 11 for any questions, star 11. One moment for the next. We have a follow-up question for Tore Svanberg from Stifel. Your line is open. Tore Svanberg: Yes. Thank you. John, just a follow-up for you. So, you know, this year, you guys demonstrated some pretty good operating leverage. I'm just thinking, as we look at fiscal 2027 and OpEx growth, obviously, you're not giving a growth target per se, but we should assume that OpEx would grow at a slower pace than revenue growth for fiscal 2027? John Young: Thanks, Tore. Yeah. We're not giving a guide at this point, but I think, you know, what we have said in the past, kind of as you articulated, is that long-term, we expect to create operating leverage by having revenue and obviously gross profit outpace the increase in OpEx on a non-GAAP basis. Tore Svanberg: Great. Thank you. Operator: Thank you. One moment for our next question. Our next question will come from the line of Kevin Cassidy from Rosenblatt. Your line is open. Kevin Cassidy: Yes. Thanks for taking my question, and congratulations to Les for a legendary career. You know, again, I am interested in that, but I want to know how much of your software and development that you've been able to work on with the automobiles for L2 to L4. Can you apply, you know, is it a relatively easy market for you to transition into, or are there other software or other issues that would happen in robotics that isn't in automotive? Fermi Wang: You know, I think, Kevin, you point out that it's really a great direction because, you know, like I continue to say, autonomous driving is just a special kind of robot. And so is a drone. And in fact, if you look at the details of functions inside an autonomous driving car, you know, level three drone and also robots. IDN is really a bunch of sensor fusion. And you make a decision on your environment, then you decide money. That you control. Either a car, drone, or some mobile robots moving around performance. From that point of view, a lot of hours have a commonality. In fact, a lot of software, if you want to do all the sensor fusion side with the perception, there's a huge among all the robotic applications. So in fact, we definitely believe that a lot of our investment both on hardware and software side for autonomous driving will directly apply to all the future phone and other robotic applications that we're talking about. Kevin Cassidy: Okay. Great. Thanks. Operator: Thank you. One moment for our next question. Our next question will come from the line of Ross Seymore from Deutsche Bank. Your line is open. Ross Seymore: Hi, guys. Thanks for asking. A couple of follow-ups. On the consumer percentage being about half of your IoT business, what was that mix last fiscal year, a year ago? Luisa Hardy: I don't have that figure for you, but I would say the dominant part of our mix was enterprise. CapEx driven markets. Ross Seymore: Got it. Thanks, Luisa. And I guess the follow-up to that is if the consumer business does sound like it has increased, does that change the seasonality of your company? I know kind of the first and the fourth quarters tend to be relatively speaking the weakest sequentials, and then the mid-two quarters are the largest. Does that change at all either directionally or kind of magnitude just because consumer is a bigger portion than it used to be? Fermi Wang: Yeah. Go ahead. You know the question. Yes. That's a very good point. And the answer is yes. And I would look at, you know, the next question is what's normal. And, really, the last three, four, five years hasn't been very normal. So I'd look at the last ten years because those first five years and the ten years, over that, did have more consumer like you're asking about. So I'd look at the average ten-year period rather than just the last two or three years, which really weren't normal. Ross Seymore: And then maybe one last follow-up. How do we think about taxes, either dollars or percentages, next year and the year after? I know it kind of goes between the dollars and percentages, and the former might be more applicable. But just an idea of how we should think about that. John Young: Yeah. Thanks, Ross. So we tend to think about it from a dollar's perspective as opposed to a rate based on the way the company is structured and where the profits are located and various jurisdictions internationally. So I would expect, well, if the dollars will increase, but it won't be, you know, they'll increase with revenue. But it won't be a significant change to the story. I think on a full-year basis, if you look at the rate on a non-GAAP basis, that'll give you some indication to be able to model going forward, I would say. Ross Seymore: Thank you. Operator: Thank you. That's all the time we have for the question and answer session. I would now like to turn it back over to Dr. Fermi Wang for any closing remarks. Fermi Wang: Thank you, and thank you all for joining our call today. And I hope to see some of you during our January event at CES. Thank you. Operator: Thank you for your participation in today's conference. This does conclude the program. You may now disconnect. Everyone, have a great day.
Operator: Ladies and gentlemen, welcome to today's VIG Conference Call and Live Webcast. I am Matilda, the Chorus Call operator. [Operator Instructions] And the conference is being recorded. [Operator Instructions] The conference must not be recorded for publication or broadcast. At this time, it's my pleasure to hand over to Mr. Hartwig Loger. Please go ahead. Hartwig Loger: Yes. Very warm welcome from Ringturm in Vienna, and thanks for joining our call with information to the main topics we have prepared for you. So we already last week announced the outstanding performance of our group for Q1 to Q3. So today, we have the chance to deepen the information about this very successful first 3 quarters of this year and which was also announced that we already raised the outlook for our profit before taxes for this year 2025 to EUR 1.1 billion to EUR 1.15 billion. And Liane Hirner, our CFO, will then give more details to the topic of the results of the first 3 quarters. The second big topic, and we know that there is big expectation also from your side that we today are ready to give you first information about our interest in Nurnberger, and we also released the information that the public purchase offer, which ended on the 21st of November this year at an acceptance rate of 98.38%. So out of that, Gerhard Lahner, he is responsible Board member of VIG for this project. He also will give some information in detail about this topic. Myself, I will then follow with information about the new strategic program in the name of Evolve '28, which will be the new strategy for '26 to '28, and which will not only further strengthen our group, but mainly will focus also on the long-term profitable growth. Today, I will offer you the structure, the main topics. And I have to excuse that the targets to this strategic program will be approved by the Supervisory Board next week. So we will come to the detailed targets back to you as soon as possible after the approval of next week. We also are happy and glad that Peter Hofinger, Deputy CEO of Vienna Insurance Group is also attending this meeting and is also ready for questions from your side after our presentation. Saying this, I hand over now for the first topic about the performance to our CFRO, Liane Hirner. Please go onward. Liane Hirner: Thank you, Hartwig. Let's start on Slide 4 with the key figures over the first 3 quarters this year, which highlights the ongoing strong performance of VIG. Insurance service revenue of EUR 9.7 billion is up by 8.6%. Here, both P&C and Life & Health showed top line growth of more than 8% each, and I will go into more detail on that on Slide 6 in terms of the individual market development. Profit before taxes as preannounced last week and despite the goodwill impairment taken already at half year for Hungary increased by 31% to EUR 872.8 million. Main driver for this outstanding profit before taxes growth in the third quarter was an excellent technical result in P&C supported by low net combined ratio. The biggest contributor to this more than EUR 200 million additional pretax profit in absolute terms was Czech Republic, followed by Austria in the Special Markets segment. VIG's P&C net combined ratio improved to 92.1%, driven by favorable weather conditions. Our strong capitalization is reflected in a solvency ratio of 286% compared to the solvency ratio at half year of 278%, the SCR of roughly EUR 4.1 billion remained fairly stable, mainly due to the slightly higher capital requirements for non-life, life and health insurance, reflecting the increased business volume. The own funds of VIG of about EUR 11.7 billion increased by almost 4% or more than EUR 400 million in the third quarter. This is driven by operating earnings and the positive development also on the capital markets, resulting in higher market values of our investments. The solvency ratio, excluding transitional measures, stands at equally very strong 267% and increase also compared to the half year. It is clearly above our solvency target range of 150% to 200%, which does not consider transitional measures, and this also underpins the capital strength and the resilience of our group. Now on the next slide, we show the gross written premium development by segment. Premiums overall increased by 8.6% to EUR 12.5 billion. Double-digit growth rates were recorded in Poland, plus 13.5% and the Special Markets segment, plus 18.4%. The strongest contribution in absolute terms is coming from the Extended CEE segment, plus EUR 314 million, where especially Romania, Hungary, Slovakia and the Baltics made up for close to 3/4 of the additional premium. Special Markets, mainly driven by Turkiye as well as Austria, Poland and the Czech Republic, all increased their premium volumes by more than EUR 130 million each. In IFRS terms, this relates or translates into a very solid insurance service revenue development, which is shown on Slide 6. Here, in line with gross written premiums, the insurance service revenue also increased by 8.6% to EUR 9.7 billion. I would like to draw your attention to the Extended CEE segment. Insurance service revenues of overall EUR 2.87 billion already exceeds the level of Austria. Again, it's the market in the Extended CEE segment, for example, Baltics, Slovakia, Romania and Bulgaria, performing extremely well. In the Special Markets segment, it's a dynamic business in Turkiye despite hyperinflation, which accounts for the significant increase. This segment also includes Germany, Georgia and Liechtenstein with Germany and our Life and Non-Life companies InterRisk, they are contributing EUR 140 million in insurance service revenue. Last but not least, Austria, Czech Republic and Poland, all 3 with solid growth rates and a strong performance also in the first 3 quarters this year. The dynamic top line development of our group supported by weather-related claims translated in the third quarter into an exceptionally strong increase of our profit before taxes. On Slide 7, you will find a short summary of the results development and the figure for the net weather-related claims recorded in the first 3 quarters. Compared to about EUR 338 million in last year in the first 9 months last year, which were related to storm Boris, we recorded only EUR 160 million of weather-related claims so far this year, thanks really to the absence of the severe nat cat events. As already mentioned by Hartwig, the strong performance of our group so far this year provides us with the confidence to raise the target range for the group profit before taxes between EUR 1.1 billion to EUR 1.15 billion for the whole year 2025. Finally, I would also like to highlight the rating upgrade by Standard & Poor's, confirming VIG's excellent A+ rating and raising the outlook to positive. This was driven by our progress in broader diversification and followed the announcement of our intention to acquire a controlling stake in NURNBERGER, which was very positively received by Standard & Poor's. With this, I hand over to Gerhard, who will now share his insight to NURNBERGER with you. Gerhard, please go ahead. Gerhard Lahner: Thank you, Liane. Let me provide you with some background and also my personal take on the NURNBERGER transaction to explain you the strategic rationale and why we are highly confident that this is an excellent fit and will increase shareholders' value over the mid and long term. The following slides in this presentation will substantiate my top-down view and provide you with further details on German market and NURNBERGER. Let me draw your attention to the disclaimer on Page #8 and specify that we are still in the nondisclosure phase of the due diligence. And let me stress out that any figures published by NURNBERGER are seen in -- are to be seen as National GAAP German accounting principles, which are not comparable to IFRS 17/9. Well, earlier this year, VIG was approached by NURNBERGER management whether we would be interested to start talks about potential strategic partnership. Given the attractiveness of the German insurance market for VIG as a Special Market, with a high insurance density and penetration while being one of Europe's largest and most mature markets, well governed by BaFin, we entered into these discussions with a clear aim to increase our exposure in Germany in combination with our local company just recently mentioned by Liane, InterRisk Life and Non-life. So it should be clearly stated that this is not a market entry, but this is an expansion on an existing market that is with the VIG portfolio for 35 years plus. After first talks, both sides quickly realized that joining forces and simplifying the shareholder structure would be the most efficient way to return NURNBERGER back to a profitable and stable company. With a state-of-the-art IT landscape to best leverage on the strong brand and the sales footprint in across Germany. From our perspective, it became clear right away that NURNBERGER management has a clear strategic vision for the company to become a profitable player in the German market with a clear focus on prevention, occupational disability and a restructured Non-Life portfolio. Well, against this backdrop of the strong commitment of NURNBERGER's management, the cost efficiency program started by them Back to Black for the Non-Life part, but also the further diversification potential through the partially complementary life insurance portfolio and the experience in turnaround and IT transformation that VIG would bring to the table, we intensified our discussion. We strongly prepared for the nonbinding offer phase and we were finally granted exclusivity for a detailed due diligence. And in this due diligence, we clearly found ourselves confirmed in our basic assumption, which was further supported by the publication of NURNBERGER half year's result that the management is well on track to deliver. Right from the beginning, it became clear that the solid solvency position of NURNBERGER is, of course, combined with the attractive brand, the countrywide operating sales force and the strong determination of the local team to get back to the historic level of profitability, a very attractive asset. The unrestricted Tier 1 of EUR 1.9 billion will strengthen VIG's resilient foundation for further expansion in CEE, which clearly remains the strategic focus of our group. Through this transaction, right after closing the deal, all Tier 1, Tier 2 and 3 limits will increase as NURNBERGER has become part of VIG Group and therefore, provides the potential for further growth in CEE without diluting existing shareholders. At the same time, the risk profile of the SCR of NURNBERGER will provide a buffer when it comes to VIG's sensitivity of shifting interest rates downward out of the Austrian life back book. Most importantly, the investment can be financed from VIG's own liquid funds, providing us with the flexibility to optimize our funding structure in a more opportunistic way and taking benefit of deleveraging the last period. In addition to VIG's own funds, there is also a EUR 500 million revolving credit facility in place. So given the spirit of local entrepreneurship at NURNBERGER, the multichannel distribution system across Germany and a conservative reinsurance policy, we are very confident that the multi-brand approach with a strong NURNBERGER brand, combined with the additional scope for further diversification is going to support our operations in Germany in a profitable way, providing a resilient internal financing structure source when it comes to the future expansion in CEE region. As we are convinced that biometric risk in connection with occupational disability is a core competence that will be increasingly relevant to support our business in different Central and Eastern European countries, the addition with NURNBERGER team and their know-how in this field is just a perfect fit for VIG. In terms of cultural fit, with NURNBERGER being an independent insurance group for the last 140 years, the entrepreneurial management style as well as the historical proximity for Germany and Austria will provide a good foundation for NURNBERGER to become a strong member of VIG. In summary, we had a chance to look into the books of NURNBERGER and are confident that the company's turnaround will be successful. And through the acquisition from VIG truly supported by our involvement. So given, first, VIG's experience in turnaround non-life portfolios in challenging market environment; second, VIG's experience in IT transformation, especially in Austria, where the digital landscape is very similar to the ones at NURNBERGER and was successfully completed in 2023, a strong NURNBERGER management with a clear vision how to generate consistent cash streams for VIG's further growth in Central and Eastern Europe and VIG to leverage on the know-how of NURNBERGER in biometrics and occupational disability, VIG will benefit from the NURNBERGER's strong solvency position from day 1, enhancing its internal financing capacities over the midterm. Please note that after the announcement, intention to acquire NURNBERGER, Standard & Poor's, as mentioned by Liane, upgraded our rating A+ with a positive outlook with a particular focus on our financial strength and diversification potential for further growth in Central and Eastern Europe. If you allow me now, I would like to go -- to hand over to Hartwig Loger, CEO, for the presentation about the strategy. Hartwig Loger: Thank you, Gerhard. I will now give you the first insight about the structure of the new strategic program for '26 to '28. As you all know, we are still in the end spirt of the group-wide strategic program, VIG '25 ending this year. And I think with the expected performance, we raised, as we already said, to EUR 1.1 billion to EUR 1.15 billion, we see also the success of the activities of our running strategic program. With Evolve '28, as you can see also on the Slide #16, we used also a name which gives the first intention what we are looking for. It is not the big revolution, but a dynamic evolution, which is built up on the success of the last years and also the current performance we can show as VIG. The frame, which is shown here is in our understanding of the, I would say, USB model we are living as VIG. Our understanding is not being a big tanker in a centralized form, but being a dynamic fleet with responsible ships and this framing, which is shown here in these 4 parts will secure that this fleet has a common direction and the strategic performance also in the upcoming years. To start, maybe also in the description, you see on the bottom Values and Principles. I will go deeper afterwards, but we already were sure that it is the need maybe also to evaluate and also to a little bit, yes, renew the values and principles for the upcoming years and the challenges we are seeing in front. On the left side, with country portfolio and company strategies, this is more or less the backbone of this strategic part for the next years. What is meant, and I will also show afterwards, there are 50 individual company strategies. So over the last year, we developed under a common structure and on the basis of deep analysis of each market, a common strategic implication for each market of our group. And then the CEOs of the companies in the markets developed their company strategies for the next 3 years, and they were following a common structure of 5 strategic fields. This means that this framework for the next 3 years already has a detailed definition for each company of our group in targeting and action plans for their activities to improve the performance also for the next years. You see the group programs. We defined also 5 group-wide programs. These programs are not initiatives as we have defined it in VIG '25 because initiatives have been the offer to the companies in our group if they will also join these initiatives, the 5 group programs now we are focusing are really for group-wide activities seen, and they are coordinated by the holding or also competence centers out of our group. On the right side, you see also the fourth part, which is ongoing in CO3. Here, we define our activities in communication, collaboration, which is needed to really bring added value out of the best practice and the innovation and creative projects in between the group and cooperation, which is focusing also to find the synergies in between the companies working on one market. On the next slide, you get the overview. I will not now present in detail, but we clearly define the 5 values for our group. Plurality, which is the basis for our fleet. We have not only 50 companies in 30 countries, we also have a very high diversification in between also the different markets, the different brands, also the different sales channels. We are active all over our brands and companies. We have the basis of our 33 million customers already, which will be improved and increased also by incoming NURNBERGER customers in Germany soon. And this is the Plurality basis, which is also our understanding that this Plurality in the activity of the fleet is the added value of our model. Entrepreneurship following this Plurality idea means that especially the local entrepreneurship, the self-responsibility in between the management of the ships in our fleet and the companies, it is the strength and the motivation and identification of all our managers and leaders. Responsibility on one side, of course, to the society, but also as we know, out of the challenges of climate change, there is a broad basis in our understanding that we want to make sure that our economic value today is not in any form destroying the future of our society. Excellence, which is clear in the focus of our company activities on the customer basis to make sure that in all our services, products, processes, we are focusing also to deliver excellent services and products, and that's the base of our performance. And passion, it is needed also to create and find out the right form that we are clear for our 33 million customers, yes, I would say, best partner in all our solutions. The Principles on the next slide, we also evaluated to make sure that the description in the way how we work together in this group. And I'm open to say that the interest also in the partnership, which was developed now also in the purchase of NURNBERGER that NURNBERGER, as it was also said by Gerhard Lahner, it will be a perfect strategic fit also in the understanding of a group-wide common activity also in the future. Now a little bit deeper in the content on Slide #19. You see here the 5 strategic fields. This is the common structure of each individual strategy of each company of our group. The one field, the most important and the first one is the expand of the customer base and also the enrichment in the activities that there, we will focus in all the companies in also cross-selling and upselling potential out of this base we already have and this base, we also want to increase in the number of customers. The second topic in line is to enhance the distribution footprint. As you know, we have a very strong diversified sales channel activity. And including also bank and direct sales, it will be the basis to improve on a better way and also to use also the challenges and advantages which will come up in the development also on digital basis. And also, we will come further on to that in artificial intelligence solutions in services which are provided in this form. Next part is Products. We enlarge also the product offerings. It was mentioned that here, we use the collaboration in between the group really to improve also the broad Plurality of offerings we have. And also besides this, there will be added services also as basis to strengthen our customer experience. Next is Operation. This field, the strategic field in each of the strategies of the companies is focusing on the effectiveness and effectivity of processes in our operations and also with improving the automation in between these processes in best practice forms in between the group. And last but not least, the fifth and very important basis employees to foster the people who are already active and to find also the best experts in our companies, which are needed for the innovation transformation we see all over our base. On the next slide, here, you see the 5 already mentioned group programs. which were developed also on a broad discussion basis in between the CEOs of our group. Here, we build on the relevant trends. We also discussed on broad basis, the trends already existing and upcoming for the next years and the challenges. And out of that, we clearly defined the main programs on one side, sustainability, which is an ongoing program, which has already been started 3 years ago. But there will be, again, a strong focus in delivering also solutions on the basis of underwriting as our key activity, but also in the asset management and operations field and which is important also for VIG to not only focus on the ecological part, but also on the social part, which includes society, our customers and also our employees. Capital management. In the understanding of the group, it's very important also for the efficiency in between the capital management of our companies in the group. And Gerhard Lahner is leading this capital management program starting in a pilot last year, and we will work out for the next 3 years that we have a very professional also management of the upstream of dividends out of the performance of our companies. Banking cooperation, which is mainly driven by the backbone, which we have in the strategic partnership with Erste Group, but we will not only work on the improvement of this strategic partnership with Erste, where we are active already in 7 markets together. And we also see the opportunity all over the group in all the other markets to expand with additional partners beside the 7 markets of Erste. Artificial intelligence, I think it's clear for all of us that there has to be a focus in the activities, which already is on a broad basis. I sometimes already mentioned that in the activities of our VIG Accelerate program, more than 50% of the projects which are brought in by the companies in this kind of platform of project for digital solutions, we have more than 50% already on the basis of AI. But it is needed, and this is what we will focus in the next 3 years to optimize also the efficiency in the use of the use cases in between the group and all over the group. And the fifth program, focusing on health, which we see in all the markets in different forms as a high potential for developing not only on product, but especially on service basis, and there, we also will have a focus in analyzing and then also supporting our companies in a group-wide form on these solutions. The next slide, evolve28, CO3, I already mentioned, I will not go deeper. Just repeat, collaboration here shown in the symbol of Spider-Net. This is really supporting the added value created out of the broad innovation and creative basis of all our companies. This is really, I would say, a boost in the way of creating new solutions in all forms in between our business. Cooperation, yes, inside, we say ensures independence in the way that there is a clear focus in the optimization of the cooperation in between our companies in one market. For example, in the back office optimization between Wiener Stadtische and Donau in Austria, also other companies in Czech, Slovakia, Poland, and there is a big range where we can deepen also the optimization, partly also automization of common activities. Communication already mentioned, we have as information already provided more than 40 communities, which are active in between our experts and specialists in between the group. So there is also a very strong interlink between our fleet. Last but not least, on the Slide #22, I offer to you also knowing your expectation. And we already mentioned by myself and also Gerhard Lahner, there is still a little need of patience from your side. Why? We have now the performance of Q1 to Q3 for this year, and we also raised our outlook for the result of '25. Regarding now the program evolve28, which I shortly presented in its structure and content, there will be the next week, our Supervisory Board meeting where we will approve the targets for the next 3 years, including also the targets coming up from evolve28 strategic program. What we can offer is then next week after the Supervisory Board meeting, there, we will also then comment and declare the targets and the figures for the next 3 years to you. And Peter Hofinger and me, we will join also in a dance program, all bank conferences, which are offered in London, in Frankfurt, in Hamburg and also the others, where we then hope that we will have the chance also to present to you maybe also in personal talks then not only the program, but also the targets and some interesting discussions. The closing of NURNBERGER. And I know that there is a big expectation also regarding the detailed KPIs and targets from the inclusion from NURNBERGER, but we still have the need that the closing, which we expect until the second half -- beginning of second half of '26, there will be then the start of the financial integration, which cannot be done before. But immediately after this financial integration phase, we will also have the chance then to integrate the targets of NURNBERGER also in the strategic targets of this evolve28 program. And then we really can not only opens, but give a deep insight in also the calculations and also the valuation of all this influence of integration of NURNBERGER. So I know that there might be a bigger expectation, but there are also the legal frameworks we have to declare. And out of that, we are also open now to answer your question, and we are looking forward to the first questions you have. Operator: [Operator Instructions] Thank you very much. The first question comes from the line of August Marcan from UBS. August Marcan: I have too many, but let's start with 3. First one on the combined ratio. This year, the 9-month combined ratio benefited a lot from benign weather. And last year, we had worries. So in the last 2 years, we kind of had the opposite extremes. So I was wondering if you could tell us what you see as a normalized combined ratio level for the group going forward? Then the second question, a rather simple one, apologies for that on your new strategic plan. I'm not sure I fully understood the time line. You said that next week, you're going to have the approval from the Board. Are you then immediately going to have an event or publish this? Or what exactly is the time line? And if -- again, on the CMD, you said that the financial targets are going to be published there. Could you just tell us now if -- what the KPIs are, not the numbers, but what the metrics are that we're going to be looking at because I think your last strategic plan didn't have a lot of financial KPIs. So I'm not sure what this one will include. Peter Höfinger: Thank you for the question to the combined ratio. Yes, you are quite right that the comparison of last year to this year is quite difficult as having Boris, which was a gross claim of but you know and we have presented this that we do have a quite conservative reinsurance policy. We are still able also over the last years in the hardening of the reinsurance market, keeping low self-retention. So also last year, for the first 9 months, we had a combined ratio of 94.3%. This year, it is considerably better with 92.1%. But you also see that the difference, if you compare the amount of the events is not so significant as we have as a mitigation element, reinsurance, which we are willing to buy in quite in a bigger amount. What was beneficial this year to our results, and this is outstanding is the phenomenon of having less frequency of small- to medium-sized events. So this has had quite an impact on our improvement of our loss ratio. The mild climate and the absence of this frequency of small to medium events, we are not impacted in a year by the big events due to our reinsurance. So therefore, I think you see the limited volatility of our combined ratio from last year to this year, having a very big event and having this year an outstanding event. So I think between 92% and 94% is what is our combined ratio to be expected going forward. Hartwig Loger: Okay. Thank you, August, for your question. I will take question 2 and 3 from my side. First, yes, there will be also an information immediately next week when we have the approval from the Supervisory Board to the targets 26 to 28 next week. And what you can expect, there will be a very transparent basis also in the information about these targets. It will be a target about the growth a target about profits. It will also include combined ratio, which you asked before to Peter Hofinger. And there will be also a target clear on return on equity as an operative return on equity, and there will be also targeting the solvency ratio. So these are the targets which will be discussed in the Supervisory Board, and then we will clearly make it transparent to the capital market about the targets we have for the next 3 years out of our program. Operator: Next question comes from the line of Rok Stibric from ODDO BHF. Rok Stibric: Yes, I would have just one question and it's -- forgive me if I'm being a bit impatient. Usually, you disclose these things with half year and full year results, but I would still like to hear your view on future investment income expectations. So the question is, do you expect future investment income to be roughly at the same level as this year? Or do you expect this line of your P&L to improve in the future or maybe given the changing interest rate environment to even decrease? I was just wondering what your thought is on developments in the future. Liane Hirner: Liane, I'm happy to take your question regarding the investment income. What I can say is that we have a very positive development in the investment income in the first 3 quarters. So this year, so no impairments, no one-offs. Also, we have a positive development of the interest rates, especially in CEE also, for example, including Turkiye. And due to the increased business volume, also interest income or financial income is increasing. So I would expect a positive development also on this side in the upcoming quarters. I hope this answers your question. Operator: We now have a question from the line of Youdish Chicooree from Autonomous Research. Youdish Chicooree: I've got 2 questions. The first one is on the top line development. I was wondering whether you could provide a split between Life and the main lines in Non-life, like [indiscernible] other property, et cetera? And then secondly, on NURNBERGER, could you tell us, I mean, how long will the turnaround of this business take? And are you able to share what your view is of the sustainable earnings power of that company, please? Peter Höfinger: Okay. I'm happy to take the question about the development of the business lines. If you look on our non-life portfolio, so we are growing all over the group in health business. And what is very positive to see, we are growing by 12% in health. What is very positive to see that we have a quite very good dynamic in health business in Central Eastern Europe. We see a growing demand by our clients and by our markets getting health insurance, and we are having quite innovative concepts and also offering this market-to-market depending on result. On the framework of the social security laws there. We do have a growth in property and casualty of around 5.6% all over the group. Also here, you will see a stronger growth dynamic in Central Eastern Europe as this is also linked to the overall GDP growth and the economic dynamic. And as you know, there is a quite positive GDP growth in Central Eastern Europe, where we are benefiting with our property business. When we come to the motor business, we have to differentiate between motor TPL and motor own damage. In motor TPL, it is around 11%. And in motor own damage, it's more than 6%. The background here is over the last years, we have seen in Central Eastern Europe quite an overproportional salary inflation. Differently to maybe Western Europe, increased salaries more or less go immediately into consumption and not just on the savings book. Part of this consumption also goes in cars and buying new cars. This is the growth driver for motor own damage, but also in motor TPL. If you look on the Life business, I think you also asked, overall, the life business is growing by more than 8%. Here, it is the classical life business, which is growing, but also in unit-linked, we are closer to 6% of the performance. So also here, we have, I think, a quite attractive dynamic. The same true, what I said for the other business lines. The driver of this growth is Central Eastern Europe, where the demand for old age savings is growing, and we also see this as one of our further future potentials of growth in the years to come. I hope I have answered your question. Gerhard Lahner: Let me take the second one on NURNBERGER. I will -- in my first part of the answer, I will refer to publicly available information. NURNBERGER itself has announced that the turnaround for the non-life part will last until 2027. We have seen quite a strong development this year, supported, of course, also by favorable claims development as well as a positive market cycle on the German insurance market when it comes to non-life profitability. So we trust the management to be well on track with the turnaround of the non-life part. The IT part will take probably a little longer. Nevertheless, given the status as which -- in which we are as of today, I think that we will have the chance to have more deep dive with NURNBERGER management on that issue when the closing has been done. Nevertheless, we are aware of that this will, of course, also long term decrease the cost base. So I think that from our point of view, we are -- I think that the NURNBERGER management is well aware of that we are expecting them when you ask me to return to historical profitability levels. As you know, not only you are impatient, but we as well -- I guess this is also well known to the NURNBERGER management. Youdish Chicooree: And can I ask a follow-up question, please? Gerhard Lahner: Yes. Youdish Chicooree: So you're expecting the closing in the second half of next year. So do we have to wait till then to get, let's say, IFRS 17 numbers for NURNBERGER basically? Gerhard Lahner: I would like to give you a different answer, but the answer is clearly yes. Operator: [Operator Instructions] The next question comes from the line of Thomas Unger from Erste Group. Thomas Unger: I'll connect to the last question and answer on. NURNBERGER. What can VIG do here to advance and accelerate the transformation process for NURNBERGER? And you already said that the time line remains about the same as what NURNBERGER guided. But when do you expect the first dividends from NURNBERGER to VIG? That will be my first set of questions. And upon closing, do you expect any significant one-offs to be incurred or immediate major investments that you anticipate for the second half of 2026? And then also, I'd like to ask you now that you're in the process of this takeover, how does that affect your growth strategy in Central and Eastern Europe? Are you able to take advantage of any M&A opportunities or other growth opportunities that may arise in the next 1 to 2 years? I don't know you haven't said anything or any details given any details on the capital hit that you'll be taking as you attractive opportunities in Central and Eastern Europe in the next 1 or 2 years? And if you allow me to also ask you on the dividend, the upcoming dividend from 2025 earnings. Will the NURNBERGER acquisition in any way affect the management Board's decision process leading up to the dividend proposal from 2025 earnings? Gerhard Lahner: On what can VIG bring to the table? I think that in different markets and especially in challenging market circumstances, I guess that VIG has shown that we know what it means to turn around, especially non-life portfolios. But I think that what we see is that the NURNBERGER management is very well in place and know what they do on the restructuring and turning around the non-life portfolio. Nevertheless, I guess that we can bring some know-how. In addition, I think that I'm not sure if everybody is aware of, but VIG has taken advantage of IT transformation program executed by Wiener Stadtische and Donau [Insurance] the last years ended in 2023. And what VIG can bring to the table is that given the fact that the IT landscape is very, very comparable to -- between VIG in Austria and NURNBERGER IT landscape, we are very confident that we know what needs to be done, first point. Second point is when it comes to talent, we have the team that was successfully doing this transformation in the DACH region still on board. You just should probably know that we decommissioned a lot of all systems in Austria which finally gives you also going forward, quite some flexibility on the digital journey that, of course, you need sooner or later. Second of all, dividend expected. I think that, in general, our intention is that NURNBERGER will keep on paying dividends in general. Nevertheless, of course, we -- and this leads to, I guess, your third question, one-off investment, we will need to judge what is the best way to finance the long-term IT transformation program of NURNBERGER. Nevertheless, we don't expect this to be a big upfront amount, but probably be spent over several years. And then we would probably judge on what is the most efficient way to deploy capital in NURNBERGER or within the entire group. I guess the fourth question is twofold. One is the financial part of the flexibility for further -- taking further advantages of inorganic growth or M&A transactions in Central and Eastern Europe. And the second one is the managerial question. I would take the first part. So definitely, given the deleveraging that VIG has gone through the last periods and the financial flexibility that we have from our balance sheet, I do not see any immediate restriction out of either the transaction nor anything upcoming. The managerial part of the answer, I would ask probably Hartwig Loger to give you the answer. Hartwig Loger: Okay. Thank you, Gerhard. I will take also the question about our possibility also to invest and go on in the growth of Central Eastern Europe. This is clear the target, and we also including our investment in NURNBERGER, we are ready and also in part of the program of evolve28, we are still interested in possible profitable growth and also investment in the enlargement of our activities in Central Eastern Europe. And as we expect maybe coming up soon also with some targets, we have also already on our radar. I think the most important thanks also for that question, our investment in NURNBERGER will not have any impact to the dividend payment out of the outperformance of '25, which is expected. So we have the clear definition of our policy to dividends. So there is the floor, and we are clear that with the performance on the operative side, there will be also the definition and the increase on the dividend payment for this year. I hope this gives security to you. Operator: We have a follow-up question from the line of August Marcan from UBS. August Marcan: Two quick questions on NURNBERGER. One is with this acquisition, you're getting some businesses that maybe are not core for Vienna like the banking business. Have you considered what you want to do? Do you want to keep the business, keep NURNBERGER as a whole? Or are you looking to dispose of the non-insurance asset that NURNBERGER has? And then the second question, you're also bringing from NURNBERGER a sizable investment portfolio and their asset allocation is quite different from yours. They have much more equities and a bit more real estate than you do and much less bonds. Have you considered what the plan is here? Are you going to move them to your strategic asset allocation? Or are you going to leave it as is? Gerhard Lahner: Thank you very much for those questions. The first one is it's probably still too early. Definitely, the focus of the acquisition for us is the core business, which is the entire insurance business of NURNBERGER. So this is the focus. The rest we will see further down the road when we are able to judge immediately after closing. The second one is on the asset allocation. VIG will not move away from the conservative asset principles that we have in place. Of course, there is an interlink between the asset portfolio of NURNBERGER. So we will first very thoroughly analyze what are impacts. But definitely, we are supposing to continue VIG's conservative investment approach in the long run. Operator: Ladies and gentlemen, that was the last question. I would now like to turn the conference back over to Nina, Head of Investor Relations, for any closing remarks. Higatzberger-Schwarz Nina: Thank you for your participation in today's call and your questions and interest. As mentioned by Hartwig Loger, our CEO, our evolve28 targets will be announced next week. Investor Relations is available to provide support and assistance with any further questions or requests for meetings. And I hope to be in touch soon. In the meantime, goodbye. Operator: Ladies and gentlemen, the conference is now over. Thank you for choosing Chorus Call, and thank you for participating in the conference. You may now disconnect your lines.
Operator: Ladies and gentlemen, thank you for standing by. Good morning, and welcome to Amentum's Fourth Quarter and Full Fiscal Year 2025 Earnings Conference Call. Today's call is being recorded. [Operator Instructions]. I would now like to turn the call over to Nathan Rutledge, Senior Vice President of Investor Relations. Please go ahead, sir. Nathan Rutledge: Thank you, and good morning, everyone. We hope you've had an opportunity to read our earnings release, which we issued yesterday afternoon and is posted on our Investor Relations website. We have also provided presentation slides to facilitate today's call. So let's move to Slide 2. Please note, this morning's discussion will contain forward-looking statements that are subject to important factors that could cause actual results to differ materially from anticipated. I refer you to our SEC filings for a discussion of these factors, including the Risk Factors section of our annual report on Form 10-K. The statements represent our views as of today, and subsequent events may cause our views to change. We may elect to update the forward-looking statements at some point in the future, but specifically disclaim any obligation to do so. In addition, we will discuss pro forma financial measures prepared in accordance with Article 11 of Regulation S-X as well as non-GAAP financial measures, which we believe provide useful information for investors. Both our earnings release and supplemental presentation slides include reconciliations to the most comparable GAAP measures. We do not provide reconciliations of forward-looking non-GAAP financial measures due to the inherent difficulty in forecasting and quantifying certain significant items. These pro forma and non-GAAP financial measures should not be considered in isolation or as a substitute for financial measures prepared in accordance with GAAP. Our safe harbor statement included on this slide should be incorporated as part of any transcript of this call. With me today to discuss our business and financial results are John Heller, Chief Executive Officer; and Travis Johnson, Chief Financial Officer. We are also joined by other members of management, including Steve Arnette, Chief Operating Officer. With that, moving to Slide 3, it's my pleasure to turn the call over to our CEO, John Heller. John Heller: Thank you, Nathan, and thank you, everyone, for joining us today. Fiscal year 2025 marked Amentum's first full year as a public company, a transformational year that helped define who we are, our differentiated position in the marketplace and where we're going. It was a year of disciplined execution, strong performance and meaningful progress across every part of our business. I am so proud of our people and what we've accomplished together. At Capital Markets Day in August of last year, we established our objective to successfully integrate and deliver end-to-end advanced engineering and technology solutions to government, international and commercial customers across key end markets, including defense, nuclear energy, intelligence and space, and we're executing exactly as we had envisioned. As a result, Amentum has established a solid foundation for sustainable growth. This morning, I will detail how Amentum has proven our ability to operate with agility, deliver for our customers and create long-term value for our shareholders. I will focus on 3 key areas: first, an overview of how this exceptional year unfolded and how it positions Amentum for a promising future. Second, highlights from an impressive quarter, including strategic awards and key performance metrics; and finally, our strategy to drive Amentum's growth in fiscal year 2026 and beyond. Let's begin on Slide 4, which captures the core of our fiscal year 2025 performance centering around Amentum's people, operational excellence, financial performance and effective execution of our strategy. First, our people. Fiscal year 2025 tested our resilience and our people delivered. Against the backdrop of evolving customer priorities, our team stayed focused and delivered without pause. Our leadership maintained its steady focus on the fundamentals, protecting the long-term health of the business, ensuring continuity for our customers and ensuring that our people continue to thrive regardless of the market environment. Through a dynamic operating environment, our teams continued designing and delivering critical solutions for our customers. That resilience is reinforced by our ability to hire thousands of skilled professionals worldwide, maintaining attrition well below the industry average and in our continued recognition as an employer of choice. We take pride in being a company where people want to build their careers while having a positive impact on our world. To that end, we're continuing to expand our centers of excellence, which provide specialized technology to drive innovation and progress. For example, we recently opened our nuclear Center of Excellence in Oak Ridge, Tennessee, which serves as a strategic hub for nuclear expertise for North America. We've launched technical connection teams and mobilized an AI expert community network supporting upskilling and innovation at every level across the globe. The integration of our legacy businesses was one of the most significant in our industry's history, a massive undertaking that demanded focus, collaboration and discipline across every part of the company. Thanks to our team, we have exited all transition service agreements, completed all of our key integration milestones on time and within budget. And are on track to deliver at least $60 million in net run rate synergies by the end of fiscal year 2026. That operational readiness anchored in the strength of our people and culture is one of Amentum's defining advantages, and it translated directly into strong financial performance. As a result, we met or exceeded guidance across every key metric, underscoring our consistency and discipline. Starting with revenues, which increased to $14.4 billion, representing pro forma growth of 4%. Adjusted EBITDA of $1.1 billion, an increase of 5% year-over-year. Adjusted diluted earnings per share of $2.22 was up 11% and free cash flow of $516 million, supporting acceleration of our debt reduction objectives, bringing net leverage to 3.2x. These results demonstrate the strength of our operations and the reliability of our business model. And taken together, this year's achievements underscore the strength and breadth of our platform. In short, we executed with precision and strength, delivering on our commitments while positioning Amentum for sustained success. Please turn to Slide 5. Our disciplined execution and focus on growth translated into a series of strategically significant wins that strengthen our position across key markets. During fiscal year '25, we submitted $35 billion in bids, achieving a full year book-to-bill ratio of 1.2x and a quarterly book-to-bill ratio of 1.6x. Our backlog grew 5%, reaching over $47 billion. And at year-end, we had $20 billion in proposals awaiting awards. Our quarterly book-to-bill ratio was driven by $6.4 billion in total bookings, reflecting continued demand in several strategically important wins, including the U.S. Space Force Range contract, a new $4 billion 10-year single-award IDIQ. This award now adjudicated and booked into backlog is one of the largest services contracts ever awarded by this customer. It cements Amentum's leadership in space systems and technology and solidifies our position in this fast-growing market. In the U.K., Sellafield selected Amentum as a remediation partner for the site under a $1.8 billion 15-year contract, where we are leveraging our advanced decommissioning solutions, systems engineering and next-generation nuclear material processing and disposition capabilities. Another exciting win came from the civilian side of our space portfolio with the NASA Cosmos contract, which is a 9-year $1.8 billion joint venture award to deliver critical mission operations, systems and training solutions supporting NASA's current space flight programs and enabling future deep space exploration. In the quarter, we were notified that this award is being protested. Therefore, it is not included in our fourth quarter backlog or book-to-bill results. We are confident in the strength of our bid and look forward to its resolution. And finally, we secured nearly $700 million in awards providing a range of advanced engineering and technology solutions for intelligence customers, including a win developing and delivering AI-enabled software coding solutions. Together, these results underscore the trust that our customers have placed in Amentum to execute complex programs at scale, and we enter fiscal year 2026 with strong momentum, preparing to bid at least $35 billion. Turning to Slide 6. Fiscal year 2025 brought significant change, not just in Washington, but across the globe and throughout our industry. The transition to a new administration introduced a new set of priorities and objectives, impacting contracting time lines, funding cycles and future spending direction. For Amentum, this environment reinforced the strength and resilience of our business model. Our work is anchored in mission-critical long-duration programs that are essential to national defense, energy security and space superiority. Our diverse portfolio, which includes 20% of revenue tied to commercial and international work provides a degree of insulation from sector volatility. Combined with our strong backlog and robust pipeline, we have high visibility into future revenues. This structural agility allows Amentum to rapidly adapt to shifting priorities while delivering consistent results for customers. As the government refocuses on efficiency, speed and accountability, Amentum is well positioned. Our scale, performance record and proven operational discipline make us a trusted partner to our customers. For investors, that combination represents a low-risk, high visibility opportunity at a time when consistency and reliability are at a premium. Simply put, Amentum represents stability in a period of transition. Let's turn to Slide 7 to discuss Amentum's growth strategy. Our core growth areas where we have long-standing leadership positions across large, stable, mission-critical areas provide dependable revenue, strong cash flow and predictable returns, and they remain central to the steady performance that defines our company. These areas, underpinned by several core capabilities are deployed across multiyear, often multi-decade programs and some notable areas include RDT&E, intelligence operations and analysis, homeland security and border protection, environmental remediation and defense engineering, logistics and modernization. As an example, you can see this in work on our ITEAMS program in INDOPACOM, where we're strengthening C5ISR capabilities for the U.S. Armed Forces by applying rapid prototyping and digital engineering methods to accelerate speed to mission. It's also reflected in our support to the Naval Surface Warfare Center Crane, where we integrate next-generation sensors and apply model-based systems engineering to enhance reliability and life cycle management. Whether we're leveraging machine learning solutions in support of customers across homeland and national security missions, delivering digital engineering tools on behalf of intelligence customers or deploying advanced environmental solutions around the world, our core growth areas deliver consistent performance and create the platform from which the rest of our business continues to scale. Turning to Slide 8. Complementing that foundation are our accelerating growth markets powering our future growth, space systems and technologies, critical digital infrastructure and global nuclear energy. They are growing rapidly, fueled by generational investments in national security, energy resilience and advanced technologies such as AI, robotics and automation. They are also margin accretive, relying on advanced engineering, AI-enabled integration and high-value technical expertise. And they are global, creating opportunities across the U.S., U.K., Europe and other allied nations where Amentum's credibility and scale make us a natural choice for government and commercial customers seeking a trusted partner. Now let me provide a bit more detail on these markets. First, the rapidly evolving market for space systems and technologies is generating demand signals from both the national security community in a fast-growing commercial sector. Our work in launch infrastructure, systems integration and space flight operations positions Amentum at the intersection of government and commercial space, supporting missions that will define the next generation of space exploration and defense readiness. Next, we're excited about our growing work providing digital infrastructure solutions. Here, we're supporting advanced telecom systems, deploying next-generation data center solutions and engineering the backbone of networks for national security and commercial customers alike. For example, commercial awards in fiscal year 2025 encompass the design, deployment and optimization of 5G networks and critical infrastructure management. Through strategic partnerships and capabilities, including MDSE-enabled platforms often leveraged from work in our core growth areas, we're future-proofing networks and data centers to meet the demands of low latency, data-intensive mission environments. By combining our engineering depth with turnkey connectivity and resilient cloud architectures, Amentum is positioning itself as a trusted provider of mission-critical digital infrastructure for the world's most demanding users. And finally, turning to Slide 9. As I reviewed during last quarter's call, Amentum is well positioned to lead the next generation of nuclear power. Our teams deliver full life cycle nuclear engineering capabilities, including design and licensing to construction, operations, modernization and life extension and decommissioning. The global resurgence of nuclear energy driven by energy security needs and the explosive demand from artificial intelligence and next-generation manufacturing is creating a market with substantial tailwinds. For Amentum, this represents a multi-decade opportunity for sustained double-digit growth and meaningful margin expansion. I look forward to providing future updates on our work in the nuclear market and diving deeper into the space systems and technologies and critical digital infrastructure markets on future earnings calls. When you combine the durability of our core growth areas with the momentum of our accelerating growth markets, the result is a portfolio that delivers both stability and scalability. Our lower-risk, long-cycle businesses generate the cash flow and institutional strength that allow us to incubate high-growth opportunities without compromising financial discipline or balance sheet flexibility. This is how we think of Amentum's strategy for growth, a well-positioned portfolio that consistently delivers growth, margin expansion, sustainable free cash flow and compounding returns year after year. With that, I'll turn it over to Travis. Travis Johnson: Thank you, John, and good morning, everyone. I'm excited to discuss with you today another outstanding quarter of performance that capped off what has been an exceptional first year for Amentum as a publicly traded company and to share our outlook for fiscal year 2026, which reflects momentum we're seeing across the business and underlying growth across all key metrics. As John noted, our strong finish to the year demonstrates the continued resilience of our diversified portfolio and was enabled by the extraordinary efforts of our dedicated employees around the world. Their unwavering commitment to execution and operational excellence delivered both exceptional outcomes for our customers and financial results that surpassed our expectations. With that, let's begin with an overview of our financial performance on Slide 10. I'd like to again highlight that while our GAAP results provide an accounting view of Amentum's legacy business, excluding CMS, today's discussion will focus on our non-GAAP results compared to the pro forma results from fiscal year 2024. These figures offer a combined view of the new Amentum business and provide performance insights on a more comparable basis. Revenue momentum accelerated to end the year with $3.9 billion for the quarter and $14.4 billion for the year. The strong performance was driven by continued demand and year-over-year increases in both Digital Solutions and Global Engineering Solutions and exceeded our expectations as a result of nonlabor timing and higher customer spend ahead of the government shutdown. On an underlying basis, after normalizing for the previously disclosed additional working days, joint venture transitions and divestitures, revenue growth was approximately 4% for the quarter and 2.5% for the full year. Adjusted EBITDA of $300 million in the quarter resulted in $1.1 billion for the full year, representing annual growth of 5% and adjusted EBITDA margin expansion of 10 basis points. Full year margins, which were impacted by a higher non-labor mix in the fourth quarter, benefited from strong operational performance in both segments and from our cost synergy initiatives. Adjusted net income was $154 million for the quarter and $542 million for the year, which generated adjusted diluted earnings per share of $0.63 for the quarter and $2.22 for the year. Adjusted EPS grew 11% year-over-year, consistent with the strong revenue and margin expansion performance. Moving to our reportable segment results on Slide 11. Digital Solutions generated revenues of $1.5 billion for the quarter and $5.5 billion for the year, representing 11% and 7% growth, respectively. The year-over-year increases were driven by the ramp-up of new contract awards, led by continued strength in the commercial digital infrastructure market and additional working days, which more than offset expected contract ramp downs and the divestiture of Rapid Solutions. Adjusted EBITDA increased to $116 million for the quarter and $437 million for the year, resulting in full year growth of 8% and adjusted EBITDA margins of 7.9%. Turning to Slide 12. Global Engineering Solutions generated revenues of $2.4 billion for the quarter and $8.9 billion for the year, representing 9% and 2% growth, respectively. The year-over-year increases were driven by new contract awards, growth on existing programs and additional working days, which more than offset the expected contract ramp downs and the impact from JV transitions in the fourth quarter. Adjusted EBITDA increased to $184 million for the quarter and $667 million for the year, resulting in full year growth of 3% and adjusted EBITDA margins of 7.5%. Turning to Slide 13 to cover our cash flow and capital structure highlights. Fourth quarter and full year free cash flow of $261 million and $516 million, respectively, were slightly better than our expectations and reflects strong cash earnings and our continued unwavering focus on working capital efficiency. This performance enabled additional debt repayments of $550 million during the quarter, bringing full year repayments to $750 million and reducing our net leverage to 3.2x. We ended the year with $437 million in cash, an undrawn $850 million revolver and no near-term maturities. With an enhanced balance sheet position, we now have an accelerated and clear path to achieving net leverage of less than 3x by the end of fiscal year 2026. Looking ahead, we will remain disciplined in our approach, maintaining a prudent capital structure that enables flexible and opportunistic deployment. Whether we are investing to drive sustained organic growth, reduce debt, pursue accretive strategic acquisitions or return capital to shareholders, our goals are the same: maximize free cash flow per share and deliver strong compounding shareholder returns. Simply stated, we're committed to retaining the financial strength that enables Amentum to grow, invest and create long-term value while doing so with precision, prudence and purpose. On Slide 14, let's now discuss our fiscal year 2026 outlook. Based on our bottoms-up forecast process for fiscal 2026, we expect revenues in the range of $13.95 billion to $14.3 billion or 3% growth at the midpoint after normalizing for the additional working days, JV transitions and divestitures previously mentioned. The ramp-up of new program awards and on-contract growth is expected to more than offset the wind down of certain historical programs and impacts from the federal government shutdown. While the majority of Amentum's work is mission-critical and continued without interruption, our guidance contemplates an approximately 1% impact as a result of reduced spending in Q1 on certain programs and from delays in award decisions. With less than 10% of revenues expected to come from new business and with $20 billion of submitted bids awaiting award decision, we have good visibility and are confident in our position starting the fiscal year. We expect adjusted EBITDA in the range of $1.1 billion to $1.14 billion, reflecting underlying growth of 5% at the midpoint, driven by margin expansion of approximately 20 basis points as we realize the benefits of our cost synergy initiatives as well as contract mix and operational improvements. We expect adjusted diluted earnings per share of $2.25 to $2.45, up 12% at the midpoint on an underlying basis, which assumes 245 million weighted average shares outstanding and a tax rate of about 24.5%. And finally, we expect free cash flow of $525 million to $575 million or 12% underlying growth at the midpoint, driven by higher cash earnings and reduced interest from our debt reduction initiatives. As it relates to timing, we expect first quarter revenues and adjusted EBITDA to be consistent year-over-year on an underlying basis, followed by quarterly sequential increases as newly awarded programs, including the key awards John mentioned earlier, ramp up throughout the year. Free cash flow is also expected to follow normal seasonality with the majority generated in the second half of the fiscal year as a result of fringe benefit and payroll timing and as a result of expected strong collections in the fourth quarter given our alignment with the government's fiscal year-end. Additional key assumptions for our guidance are included on Slide 14 in today's presentation posted on our Investor Relations website. Wrapping up on Slide 15. As we conclude a transformative year for Amentum, highlighted by exceeding our financial commitments in a dynamic market environment, advancing our growth objectives with key strategic wins and a 1.2x book-to-bill and surpassing our cash flow and deleveraging expectations, we are excited about the road ahead. Our portfolio is strategically aligned with enduring global trends, customer priorities and tailwinds in accelerating growth markets. While pleased with our current progress and achievements, we remain focused on delivering our strategic objectives and driving long-term value for all stakeholders. With that, operator, please open the line for questions. Operator: [Operator Instructions] Your first question comes from Colin Canfield with Cantor. Colin Canfield: Can you discuss perhaps the level of kind of timing or onetime margin and cash flow dynamics in the quarter? And then how much Section 174 benefits were included in fiscal 4Q versus the guide? And then maybe talk through if there are any kind of pull forward or pushout dynamics around margins and cash related to the merger? Travis Johnson: Colin. A little bit to unpack there, obviously, all focused on cash. Maybe starting at the top. Obviously, we're pleased with our year-end cash performance, which, as I said in my prepared remarks, slightly exceeded our expectations as a result of the strong revenue performance that we saw in the year. As far as onetime items in the quarter, obviously, we've talked about the additional working days, which generated additional cash, around $20 million is the impact from that. So that would be kind of an item to normalize as we head into FY '26. And then moving into FY '26, we're obviously really excited about the cash flow trajectory. We're expecting, as I said, 12% growth at the midpoint of our guidance on an underlying basis. And we do expect to receive some benefits from the OBA tax law changes around immediate expensing of R&D, also smaller benefits, but still benefits around disallowed interest and CapEx bonus depreciation. So altogether, that's about a $35 million benefit to tax cash payments in FY '26. So put all that together, and again, just right along where we expected to be at this point, driving that double-digit free cash flow growth that we committed to at Capital Markets Day and excited to continue to head in that trajectory. Colin Canfield: Got it. And then maybe level setting us on the multiyear margin progression in terms of the synergy targets. I think one of the thesis that kind of folks are focused on is essentially shutdown-related dynamics just pushing everything 1 year to the right, but still fundamentally happening. So perhaps if you could talk through kind of how you think about FY '26 margin progression, the synergy contribution and perhaps kind of the multiyear framework set out at the Investor Day? Travis Johnson: Sure. So as we talked about at Capital Markets Day, our goal kind of a long year -- long-term goal by FY '28 is to get to 8.5% to 9% margins. And as we sit here today, we're exactly where we thought we would be. Cost synergies were obviously part of it, but we drove 10 basis points margin expansion in FY '25 in our actual results and the midpoint of our guide for FY '26 is another 20 basis points. So all in all, 30 basis points in the first 2 years together is exactly the trajectory we thought we would be on. And then as we head into FY '27, obviously, we'll have the full year impact from all of our cost synergy initiatives. And as John said, we're on track with all of our integration activities, including cost synergies and we'll exceed $60 million in net run rate cost synergies by the end of FY '26. John Heller: And I think the other part that we talked about on the call and we introduced for the first time of our overall two-pronged strategy of growth. And that to us is really what this story is all about. As we started out a year ago, we knew this would be a transition year this year, integrating, identifying the real opportunities, the white space opportunities, the growth opportunities that neither of those -- of the companies we put together could go after. And we've really strongly set our sights on putting a strategy together that can leverage the broad enterprise of momentum. We talked about our core markets, which we're leaders across those core markets, which gives us great opportunity for sustained growth. But it's about the accelerated growth markets that we've identified. They are strong already. We're leaders there as well, but it's only $4 billion of the $14 billion company. And we think there, the growth opportunities are stronger and the margin accretion opportunities are also stronger. So driving focus in those 3 accelerating growth markets across Space Systems and technologies, critical digital infrastructure and global nuclear energy all will result in margin improvement. And that's why we're still very excited about the targets we set out and the goal of 8.5% to 9% by '28. Colin Canfield: Got it. And maybe sneaking in a third, if you could just update us on how you think about kind of the timing, magnitude and multiple of any potential divestitures as well as the timing and magnitude of the upcoming SLS award. Stephen Arnette: I'm sorry, repeat the second part of the question to what award, I didn't catch all of that. Colin Canfield: SLS. So there's $4 billion in the reconciliation bill. It's been 3 years since we've gotten a pretty major SLS award and the competitive dynamics of that race are obviously a national security focus as well. So I just want to make sure we're level set up. Stephen Arnette: Yes. Thank you for the repeat. Happy to provide just a little bit of color on the Space Force Range contract. It is a topical issue for us right now because we've gotten through successfully protest period, and our teams are busy work right now today even as we prepare to assume operation for that large contract in December. So really excited about the Space Force Range contract. Really, just a quick synopsis at the top level, work on that contract about making sure the U.S. has assured access to space. And actually, there was a great article just yesterday in the Space News publication where they interviewed Colonel Chatman, who's the commander of Space Launch Delta 45, and he talked about how the launch cadence just continues to ramp. And both on the Eastern and Western range, we're working with [ Apollo Aera ] infrastructure. He highlighted how Congress has appropriated nearly $1.5 billion to be invested between now and 2028 to begin to upgrade that infrastructure. And so for us, at Amentum, we're coming in at an exciting time to that contract. So we're there certainly to maintain and sustain and support this launch cadence, but we're also there to engineer, upgrade and integrate all the capabilities needed for the future. So very excited about how that's going to play out beginning in December, phase in underway. John Heller: Yes. So just to be clear, that contract cleared protest, we are executing on that contract today. And as Steve mentioned, very excited. The first part of your question just about portfolio shaping. We're excited to have the opportunity with Rapid Solutions in our New Zealand business and noncore, very clear noncore elements of the business. But I would say today, we're very excited about our entire portfolio, the capabilities we've put together. We're leveraging across our entire business, very important for us as we look at the company as an enterprise and don't create silos. And we're leveraging across all different capability areas as we look at every opportunity we're bidding. So right now, we're excited about the portfolio we have. Obviously, we go through strategic planning every year. We look at where the growth -- largest growth opportunities are, and we will obviously look if there are any noncore assets and identify those. But I would say, right now, we're really excited about what we've put together and it's working. Operator: And the next question comes from Brian Gesuale with Raymond James. Brian Gesuale: Nice job on the print here. I want to dig in a little bit to these growth areas, John, if I could. Can you remind us how you play throughout the entire kind of nuclear life cycle, how big that business is today? And maybe as you lay out these broad ambitions for nuclear power in the future that have been put forward, when you'll start to see some of those things inflect for your business? John Heller: Yes, sure. We highlighted this last quarter as well. So I do -- I would reference everyone to go back to that quarter. There's an additional slide there, but we kind of brought in one of the slides from last quarter into this quarter that kind of actually helps answer that exact question. So for us, what I would say is we play a mission-critical role across the entire nuclear energy life cycle. So it starts with design into construction and commissioning all the way through operation, maintenance and decommissioning. And it's really across all sectors of the industry, which starts with new development, construction and operation of gigawatt-sized reactors. It also covers SMRs, a lot of activity in the marketplace today around the world on developing that capability, that new design capability so that we could have small modular reactors existing in the United States and around the world, and we're working with a large number of these developers to help bring those capabilities to the market, but that's going to take some time. So a lot of engineering work right now through likely this decade. But then the other area is really on plant life extension and upgrades. We're seeing the 3 Mile Island News, other areas across the United States where we want to ensure that we have the electricity we need to fuel the AI data center demands and other demands of robotic manufacturing and just overall electricity demand generally. It's an important part of the economy. It's been deemed a national security priority by this administration, and we're seeing a lot of good policy coming out of this administration that's driving this renaissance within the U.S. Brian Gesuale: Great. Really helpful. I want to talk also maybe about one of the other growth areas that we're really excited about on the space side of things. Can you maybe help us understand how much of that business is commercially oriented in defense given there's just so much activity in both those areas? And maybe if you could help us think a little bit about how Golden Dome from a presence and a launch activity perspective would drive your business and maybe the timing of that, whether that's part of '26 or part of an unfolding '27 story that's yet to reveal itself. Stephen Arnette: Yes. The -- today, I mentioned, we're just super excited about where we're at in this market and the continuing accelerating growth opportunities. Just to start, I think most people are familiar with the leading presence we have supporting the government with NASA and the whole civilian space exploration and all of those activities. A lot of Amentum colleagues right now preparing for the Artemis II mission that's scheduled for early 2026, and we're excited to be such a critical player in putting astronauts back in space and really excited about the preparations for that mission, everything from integrating the vehicle, launch control software, mission control software. And I think that our recent win on Cosmos, where we'll have now an Amentum team at NASA Johnson Space Center becoming engaged in mission operations and all of the things that extend through the complete life cycle of the mission kind of speaks to our strength in supporting that customer and their missions. Of course, that contract currently is undergoing corrective actions, so we're not underway yet. but that's a really good one. As far as your question about Golden Dome, just to give a bit of insight there, we really think we have a great right to win in terms of being a part of the solution that the U.S. government is developing. Today, we're heavily engaged with the Missile Defense Agency and helping to take the missile defense system digital, if you will. It's allowed us to deploy things like the hypersonic next-gen satellites for detection. We're doing things like virtual engineering, digital methods to integrate new technologies into the system. That capability and that expertise, we're also deploying for the NORAD mission, which is the North American Aerospace Defense Command. And so we're really excited about those capabilities. And the way Golden Dome comes to life for us is right now, the government is moving out on a Shield procurement. Shield is the acronym for a large IDIQ vehicle. It will be a multiple award vehicle, $150 billion. We are engaged in that procurement like many other in the industry. And so our proposal is them. We're looking forward to the adjudication of that. And I think that specific to your question, as we get toward deeper into FY '26, we'll begin to see specific task orders and tasking come out under that Shield vehicle. So we're excited about the opportunity there. So really cutting across national security as well as civilian space, there's a lot for us to draw on in the portfolio. And I think the last thing I would mention, and it comes into play even with our new Space Force Range contract, John hit it in the prepared remarks, but so many of these contracts put us at the intersection of government and commercial space, and we have a great track record of working with those commercial partners. So we think that proven capability is going to be instrumental for the government to accomplish all of their objectives that they have for the space domain. Operator: [Operator Instructions] Next question comes from Tobey Sommer with Truist. Tobey Sommer: The company has reduced leverage faster than we anticipated. When do you think you'd be at a point where you may be able to go on offense with capital deployment and start incorporating inorganic growth into the story? Travis Johnson: Yes, certainly, we're pleased with the leverage trajectory sitting at 3.2x here 1 year in to our merger and public company transition ahead of where we thought we would be. I'd say we remain committed to getting to that target that we set out at Capital Markets Day last year of less than 3x net levered, and we're on track to do that by the end of FY '26. As you know, our kind of cash timing, 2H will be back half weighted. So we'll get there in the second half of FY '26. And so obviously, now it's right around the corner, right? So we're starting to shift our focus and what that could look like. It will be obviously dependent on what opportunities are out there and available at that point in time. But as I said in my prepared remarks, regardless of what we do at that given point in time with our capital deployment strategy, we'll be looking to maximize free cash flow per share could be part of that, but it also could be continue to pay down debt or returning capital to shareholders. Certainly, as we get out of the kind of 2-year restriction period of the RMC, looking at share buybacks when it's trading at something below the intrinsic value of the stock could be an option. So we look forward to getting there in the second half of '26. John Heller: Yes. And what I would put a bow on that discussion is really the fact that we have these accelerating growth markets that we see as organic opportunities given the -- what we've created in the new momentum. And we think we can leverage and exploit those 3 areas of space systems and technologies that Steve talked about and the opportunities that are upcoming there that are organic, the critical digital infrastructure, which we will talk about on future calls. We haven't dived into that, but really about helping the AI economy to succeed cybersecurity and then global nuclear energy, which, again, we feel very confident that we have the organic capabilities to exploit. That doesn't mean we wouldn't look at M&A in the future to help us accelerate those, but we're confident we can win and grow in those areas today. Tobey Sommer: I appreciate that. And I just sort of have a modeling question since some of the growth areas have already been discussed of interest. Are there timing or mix issues for us to contemplate near term in modeling the quarterly cadence of revenue and EBITDA across fiscal '26? Travis Johnson: So just as we look at the time phasing throughout FY '26, Q1 will obviously have the impact from the government shutdown, but that will normalize throughout the year. So we do expect quarterly sequential increases in both revenue profitability and cash flow for that matter. Maybe just to provide a little bit more color, we see digital solutions as the predominant driver of growth for the company in FY '26. Obviously, Space Force Range contract is in that segment, and that will be ramping up as we grow throughout the year on that contract. And some margin expansion in Digital Solutions, maybe a little bit more modest than what we expect to see in Global Engineering Solutions. But we do expect some revenue growth in Global Engineering Solutions as well due to continued ramp-up of some new work as well as on-contract growth. And that's where we believe a lot of the margin expansion will come from in FY '26. So you can think about FY '26 kind of quarterly sequential increases as we move throughout the year. Operator: The next question comes from Mariana Perez Mora with Bank of America. Mariana Perez Mora: I wanted to follow up on the nuclear opportunities. In the prepared remarks, you mentioned double-digit growth and margin accretive type of work. When you talk about these margins, are they accretive because they are coming like significant like EBITDA pure to the contract? Or it's mostly because a lot of them come through nonconsolidated like joint venture type of EBITDA added to the segment? And then as a follow-up to that, when we think about these opportunities, how fast can they actually come? For example, on the $20 billion that you have in the pipeline expecting to be awarded, how much of that is related to nuclear? Travis Johnson: Yes, I'll take the first part of the question, Mariana. And then John, maybe you can tackle the second part of that. When we look at the front-end nuclear energy market, it's more of the former as it relates to margin expansion, not unconsolidated joint ventures. A lot of that work tends to come not only in the U.S. commercial, but also international, right? And due to the nature of the work and our capabilities and what we're providing there, it does tend to be margin accretive to the overall portfolio. Not to say that especially on kind of back-end environmental remediation, decommissioning, there could be some joint venture opportunities that could also be margin accretive. But as we look to the future and where we expect the growth to come from out of that part of our portfolio, it's certainly not JV consolidation. It's more of the nature of work. John Heller: We talk about this market the global nuclear market, first of all, we are in this market today globally. In the United States, all across Europe, Japan, we are currently delivering capability across that entire life cycle. It represents about 17% of our business today, so very substantial. We are a leader, both in the United States and across Europe and recognized and brought into Japan because of the work that we have done in our history. So for us, it's a real business delivering real strong margins today. As we talk about kind of the nuclear renaissance that is happening driven by real demand for electricity and AI and the expansion of data centers to enable our AI economy, the demand is real. But nuclear takes time. You have to do significant design work, planning and then you go into construction. In the gigawatt size plants, which we have traditionally worked, we've been involved in every nuclear power plant constructed in the U.K. in its history. We have great expertise. In the United States, we've just not seen an industry that has been operating on a regular cadence, but there is absolute support from the current administration as well as industry. And there's -- to bring more of this capability online. So President Trump laid out executive order saying wanted to see 10 more gigawatt plants under construction by 2030. I think that's an achievable goal, but it will take a lot of work. And we are one of the leaders that is capable of supporting that achievement, working with the companies in the industry that have the designs that could be used to deliver that. On SMRs, it will take a little longer. We are in the phase of working with companies to actually put the designs together and then prove those designs so that they can be certified and approved designs that can then move into construction. So that's going to take more or less the rest of this decade to move the SMR capability to a point where we would see projects going into construction, but there will be quite a bit of engineering work between now and then. Mariana Perez Mora: And then as a follow-up to margins, fourth quarter and fiscal '26 margins came in a little bit lighter than expected according to what you said in the Investor Day. Besides the nuclear opportunity that will come with this accretive margins, what are the other drivers that will get you to the 8.5% to 9% that you expect to have by '28? Travis Johnson: Yes. Certainly, as John talked about, the accelerating growth areas in aggregate, not just global nuclear energy, but also critical digital infrastructure and space systems and technologies in total are margin accretive to the portfolio. And as we see those outpace growth of the rest of the portfolio in our core growth areas, that will lead to margin expansion in addition to, obviously, the cost synergy initiatives that we've talked about and little bit of Q&A on that today, but those will drive, call it, 30 to 50 basis points as we move through FY '27 into FY '28. So those combined are the predominant drivers of the margin expansion. Operator: The next question comes from Andre Madrid with BTIG. Andre Madrid: [ DOGE ] came to an earlier-than-expected end, it seems, probably 8 months ahead of schedule there. I think previously, you were anticipating that maybe there's going to be a 1% headwind going into '26 based on policy changes. I see that there's a 1% headwind based on the shutdown. Is it kind of just shifting towards that where it's like maybe you could have clawed some back on the policy shift side given the end of Dodge, but it's now headwind from the shutdown. I'm just trying to understand the moving pieces there. Should we expect kind of both layered on top of each other or. Travis Johnson: I would think about it, Andre, is not related at all. We obviously went through the administration change, those, all of that throughout '25, and we did call out the approximate 1% impact to the portfolio. That was back half weighted. We'll see some noise of that continuing kind of throughout the first quarter or 2 here of FY '26, but nothing significant to call out. And separate and independent of that, as we see in times of government shutdown in the past, obviously, this one was a little bit extended more than we've seen in the past, but some disruptions to spending on contracts and then some delays in the procurement environment is the 1% that we called out for this fiscal year. But all that being said, still feel good about the trajectory of the underlying business, excluding that government shutdown impact, 4% growth at the midpoint on revenue, above mid-single digits on EBITDA and obviously double digit on EPS and free cash flow despite those dynamics that are occurring. Andre Madrid: Got it. Got it. And then maybe -- I mean, just in terms of debt paydown, you've still got a ways to go -- a little ways to go until you get to less than 3 turns. I mean, how should we think about the pace of that through the year? Is it also -- are you guys thinking of going a step further? Should we think it's still a sizable portion of free cash flow for the year or. Travis Johnson: Yes. So the predominance of our cash flow will follow normal seasonality and be generated in the second half of FY '26, which is when you'll see us start to get to below the 3x net leverage that we've talked about. Andre Madrid: Got it. Got it. And maybe if I could squeeze one more in. I mean you talked about organic investments. I mean, which areas do you think are poised for the most? John Heller: Well, we talked about our core markets. We're still very comfortable with our core markets. So we're looking at investing there as well as those 3 accelerating growth markets. So all of those areas still represent real strength to the business. And yes, so we're -- I think we highlighted in the strategy where we're focused. Those are our priority areas. Operator: And the next question comes from Ken Herbert with RBC Capital Markets. Kenneth Herbert: I wanted to see first on the '26 and maybe midterm growth outlook, can you get more specific on what kind of growth you're expecting in -- I guess, from the accelerating growth portfolio, as you outlined it here as we think about sort of the 3% to 4% organic growth in '26. Are you at the high single digits for that market, the accelerating growth businesses? And then maybe how much does that accelerate into '27 and '28? Travis Johnson: Yes. So I'll start, and then, John, you can feel free to add in. So for FY '26, obviously, absent the government shutdown, as we've talked about, from a revenue perspective, expect underlying growth of 2% to 5% -- sorry, 3% to 5%, right? And that's kind of right in line with where we thought we would be at this point in time. And then as we kind of transition and start to benefit from all the pipeline and things that we did as a newly merged company and the accelerating growth markets that John mentioned in his prepared remarks, obviously, we think that will accelerate not only as we move through FY '26, but also into FY '27 and beyond. So those will start to tick up and awards such as Space Force Range, we mentioned the Sellafield award that's also in those accelerating growth markets. Those will continue to ramp up as we move into the back half of '26. John Heller: Yes. And Steve talked about some of the opportunities, I think, that we're seeing in the space market that we think will adjudicate this year and therefore, impact next year in a more significant way. And I think the same as we think about the global nuclear energy market, we continue to see an uptick in activity, which will accelerate this year through next year. So we should see a higher pace of activity in that market as we think about '27 and '28 as well. And then the digital infrastructure, we have strong activities in working with the hyperscalers on helping with design and development of upgrades to data centers, as an example, on telecom, outfitting 5G networks and beyond. So we see areas like this will also continue to expand for us as we continue to reach into other hyperscalers with these capabilities and push the growth of those into '27 and '28 as we kind of break into new customers with these offerings. Kenneth Herbert: Great. That's helpful. And just if you could remind us, what's the recompete risk or recompete exposure you have here as part of fiscal '26? Travis Johnson: Yes. So we're really confident in kind of the composition of revenue in our FY '26 guidance. Over 90% of it will be coming from firm and follow-on work, so less than 10% from new business, and it's less than 5% recompete risk. Operator: Thank you. And that is all the time we have for questions. I would like to turn it back to John Heller, CEO, for closing remarks. John Heller: Thank you. As we enter a new year, we're encouraged by our performance and confident in the path forward. Our strategy remains firmly aligned with long-cycle mission-critical markets, and we remain agile to meet the evolving needs of our customers. I want to extend my sincere thanks to our employees, particularly those who were impacted by and those who worked tirelessly to support our customers during the government shutdown. Their resilience and professionalism exemplify what makes Amentum a trusted partner. We are well positioned to capture growing demand in our core growth areas and our accelerating growth markets and to deliver sustainable long-term value for our shareholders. Thank you for your continued interest in Amentum. We look forward to sharing our progress in the quarters ahead. We wish everyone a safe and joyful holiday season. Operator: Thank you. Ladies and gentlemen, this concludes today's conference call. Thank you all for joining. You may now disconnect.
Operator: Good day, and welcome to the Abercrombie & Fitch's Third Quarter Fiscal Year 2025 Earnings Call. [Operator Instructions]. Today's conference is being recorded. At this time, I would like to turn the conference over to Mo Gupta. Please go ahead. Mohit Gupta: Thank you. Good morning, and welcome to our third quarter 2025 earnings call. Joining me today on the call are Fran Horowitz, Chief Executive Officer; Scott Lipesky, Chief Operating Officer; and Robert Ball, Chief Financial Officer. Earlier this morning, we issued our third quarter earnings release, which is available on our website at corporate.abercrombie.com under the Investors section. Also available on our website is an investor presentation. Please keep in mind that we will make certain forward-looking statements on the call. These statements are subject to the safe harbor provisions of the Private Securities Litigation Reform Act of 1995 and are subject to risks and uncertainties that could cause actual results to differ materially from the expectations and assumptions we mentioned today. These factors and uncertainties are discussed in our reports and filings with the Securities and Exchange Commission. In addition, we will be referring to certain non-GAAP financial measures during the call. Additional details and reconciliations of GAAP to adjusted non-GAAP financial measures are included in the release and in the investor presentation issued earlier this morning. With that, I will turn the call over to Fran. Fran Horowitz-Bonadies: Thanks, Mo, and thanks, everyone, for joining as we head into the important holiday season. I am happy to report our 12th consecutive quarter of growth, with sales up 7% to a record of $1.3 billion. We again delivered on the goals we outlined for the quarter, with net sales and operating margin, both at the high end of our outlook, earnings per share above our expectations and inventory levels aligned with trend. Along with these strong financial results, we repurchased $100 million worth of shares in the quarter, bringing our total to $350 million, or 9% of shares outstanding as of the beginning of the year. Our team continues to stay close to our customers while reading and reacting to the current environment. In the quarter, we made further progress on key brand, regional and foundational investments. Based on our third quarter momentum and our fourth quarter outlook, we are narrowing our full year sales outlook towards the top end of the range we provided in August, targeting a strong finish to 2025 on top of a record 2024. Financially, in addition to record net sales, we delivered a gross margin of 62.5% and a 12% operating margin for the quarter, both of which include an adverse tariff impact of around 210 basis points. We exceeded our outlook range on earnings per share, delivering $2.36 for the third quarter. On the regions, we saw continued growth in the Americas with net sales up 7% on balanced traffic gains across channels. In EMEA, total sales increased 7% with comparable sales higher by 2%. Similar to last quarter, strong sales performance in the U.K., our largest country in the region, continued to be fueled by localized marketing, inventory distortions and strategic partnerships. Strength in the U.K. was partially offset by softness in Germany and the remainder of European markets. In APAC, net sales were down 6% with comparable sales down 12%. Across regions, we remain excited about the significant long-term global growth opportunity for our brands through a blend of go-to-market strategies, including owned and operated, franchised, wholesale and licensing. Turning to the brands. In line with our expectations, we made sequential improvement in Abercrombie brands that sales were down 2% and comparable sales down 7%. We continue to see positive cross-channel traffic to the brand and we managed inventory tightly, enabling improved AUR trends compared to the first half. The sequential improvement was led by Women's, where we had a good seasonal transition to cold weather categories across top, bottoms and outerwear. In Abercrombie, we continue to remain active in marketing, building on early fall denim and NFL campaigns with our recently announced collaboration with luxury retailer Kemo Sabe. Putting these 2 brands together with a great way to connect with new and existing customers offering authentically crafted leather apparel and accessories, highlighting the Western trend. Abercrombie has inventory in the right place and a strong marketing plan heading into holiday. We've opened 30 new stores in the third quarter, aiming for a total of 36 this year. We remain focused on bringing the brand back to growth by diligently executing the playbook that has delivered a double-digit CAGR on sales from 2019 on strong double-digit AUR improvement over that time. This holiday, you'll see a lot of Abercrombie is known for, fashion, comfort and authenticity, and you'll continue to see it expressed through newness across categories. With this combination of investment across product, voice and experience, we are aiming for Abercrombie brands to be approximately flat in the fourth quarter on net sales against a record in Q4 last year. We're excited to see that milestone within reach. In Hollister, we saw exceptional growth trends continue with 16% net sales growth in the third quarter. Comparable sales were up 15% on continued strong cross-channel traffic. Both Men's and Women's contributed to growth in the quarter, and we saw balance across categories. Consistent with our Read & React model, we've been keeping inventory tight while continuing to flow in newness allowing for AUR improvement on lower promotions. Coming off a very strong back-to-school season, I was proud of the team transition to fall and into holiday. Speaking of holidays, Hollister has some exciting campaigns and collaborations planned that will highlight some must-have for the season. We kicked off a couple of weeks ago with 6 college athletes co-designing special items in our Collegiate collection for football rivalry week. And you might have seen yesterday's announcement with Taco Bell with the brands collaborated on 90s and Y2K styles across graphics and fleece. We are just getting started. And importantly, our team has been reading and reacting and has the right product to support sales throughout the season. We're also enhancing the Hollister brand with investments in physical retail. We are on track to open 25 new stores this year while refreshing more than 35. The theme across our brand portfolio and company is consistent. We remain on offense. From both a brand and regional perspective, we are investing in marketing, stores and talent to support sustainable long-term growth. We also continue to make opportunistic investments in digital, technology and our infrastructure to improve the agility and speed needed to support our growing global business. These tech investments have the power to enhance the entire customer journey, especially when paired with AI. We recently deployed AI agents and customer service to improve the experience while driving scale and efficiency. And we're very excited about a new partnership we're kicking off this week with PayPal and SymBio, one of our technology partners in marketplace sales, that will enable agentic commerce and AI answer engines like Perplexity, where customers can seamlessly complete transactions directly within their AI conversation without even leaving the chat. As our business continues to evolve, we're making future focused investments to deliver for customers and strengthen our operating model. And for us, that's really the story of 2025. More than 3 quarters in, I am proud of how the team has worked through this year, responding to the dynamic tariff environment and evolving with our customers. We are fully prepared for the holiday season having used these past months and quarters to test and learn and build confidence in our assortment and brand positioning. We've also continued to keep inventory tight with the goal of reducing promotions and clearance selling to mitigate some portion of the tariff cost. With our holiday plans in place, we expect to deliver top-tier profitability and earnings per share, reflecting the consistency of our model. And with that, I'll hand it over to Robert. Robert Ball: Thanks, Fran, and good morning, everyone. Recapping Q3, we delivered record net sales of $1.3 billion, up 7% to last year on a reported basis at the high end of the range we provided in August. Comparable sales for the quarter were up 3%, and we saw a benefit of approximately 50 basis points from foreign currency. By region, net sales increased 7% in the Americas, 7% in EMEA, partially offset by a 6% decline in APAC. On a comparable sales basis, Americas was up 4%, EMEA was up 2% and APAC was down 12%. Across regions, the spread from net sales to comparable sales was driven by net new store openings and third-party channel performance. EMEA also benefited from favorable foreign currency. On the brands, Abercrombie Brands net sales declined 2% with comparable sales down 7%. Consistent with our third quarter outlook, the sales decline was primarily due to lower AUR, but the AUR decline was less than the first half of the year. Hollister Brands net sales grew 16% on comparable sales growth of 15% with both unit growth and AUR improvement from lower promotions. The comp to net sales spread for Abercrombie brands in the quarter was driven by third-party channel performance, along with net store openings. I'll cover the rest of our results on an adjusted non-GAAP basis. Operating margin of 12% of sales was at the top end of the outlook range we provided in August, delivering operating income of $155 million, compared to $175 million last year. Adjusted EBITDA margin for the quarter was 15% of sales on adjusted EBITDA of $194 million compared to $219 million last year. The 280 basis point decline in operating margin from Q3 2024 was driven primarily by 210 basis points of tariff expense included in cost of sales. In addition, as we forecasted in August, third quarter marketing was up 100 basis points from the prior year. This was partially offset by leverage in general and administrative expense on lower payroll and incentive compensation. The tax rate for the quarter was below our outlook at 29% driven by outperformance to expectations in EMEA. Net income per diluted share was above our outlook at $2.36, compared to $2.50 last year. Moving to the balance sheet. We exited the quarter with cash and cash equivalents of $606 million and liquidity of approximately $1.06 billion. We also ended the quarter with marketable securities of approximately $25 million. For the quarter, we repurchased $100 million worth of shares, ending the quarter with $950 million remaining on our current share repurchase authorization. Year-to-date, we repurchased $350 million in shares totaling 9% of shares outstanding at the beginning of the year. We ended the third quarter in a clean current inventory position with costs up 5% and units up around 1% and have seen freight and other unit cost mix normalize. Shifting to the outlook. We entered the fourth quarter with momentum, and we are narrowing to the upper end of the full year sales expectations we provided in August. We continue to reflect tariffs and mitigation consistent with our second quarter call commentary and the team continues to find cost efficiencies through vendor discussions as we plan 2026. For the full year, we now expect net sales growth to be in the range of 6% to 7% from $4.95 billion in 2024. We've narrowed the range to reflect third quarter performance and for expected fourth quarter sales. We currently anticipate 60 basis points of favorable foreign currency in the outlook. We continue to expect full year GAAP operating margin in the range of 13% to 13.5%. As a reminder, this range includes the impact of the $38.6 million benefit from litigation settlement or around 70 basis points of sales. Also, the assumed tariffs included in the operating margin carry a cost impact of around $90 million for 2025, or 170 basis points of sales. We are forecasting a tax rate around 30%. For earnings per share, we expect diluted weighted average shares of around $48 million, which incorporates the anticipated impact of 2025 share repurchases. Combined with the tax rate, we expect net income per diluted share in the range of $10.20 to $10.50. For clarity, the $38.6 million benefit included in our outlook carries a favorable impact of $0.59 per share. For capital allocation, we continue to expect capital expenditures of approximately $225 million. On stores, we continue to expect to deliver around 100 new experiences, including 60 new stores and 40 right sizes or remodels. We also expect to be net store openers with our 60 new stores outpacing around 20 anticipated closures. At the current sales and operating margin outlook, we are targeting around $450 million in share repurchases for the year, subject to business performance, share price and market conditions. For the fourth quarter of 2025, we expect net sales to be up 4% to 6% to Q4 2024 level of $1.6 billion. We expect operating margin to be around 14%. We continue to expect lower cost of goods sold from freight at around 150 basis points of sales for the quarter. We also continue to expect $60 million of tariff impact net of mitigation efforts or around 360 basis points. Operating expense will be around last year as a percentage of sales. We see opportunities to incrementally invest in marketing, but this will be largely offset by leverage in other areas. We expect the Q4 tax rate around 30%. We expect net income per diluted share in the range of $3.40 to $3.70 with diluted weighted average shares expected to be around $47 million, including the anticipated impact of around $100 million in share repurchases for the quarter. To close things out, we entered the fourth quarter ready to compete with inventory aligned with trend and the right composition. We have great momentum having delivered against expectations these past 3 quarters on both top and bottom lines. Our brands are in great shape with Abercrombie brands making sequential improvement and Hollister brands taking share with impressive growth. We remain on the offense, investing in marketing through key brand collaborations and partnerships and with store expansion and digital enhancements that enable us to win in the long term. We look forward to a great holiday selling season. And we thank our teams around the globe for putting us in reach of record sales for fiscal 2025. And with that, operator, we are ready for questions. Operator: [Operator Instructions] First question comes from Dana Telsey with Telsey Advisory Group. Dana Telsey: So nice to see the sequential progress. Congratulations. Fran, as you think about the Abercrombie brand and the plan it's tracking to, what did you see by category, Men's and Women's? Does it differ by channel? How are you seeing the progress of the brand? And then just overall, international, any puts and takes on the different regions and countries? Fran Horowitz-Bonadies: Dana, so super excited about the results we just put up for the third quarter. I mean total company 12th consecutive quarter of growth, top line is 7%, comps at 3%. So the Abercrombie brand specifically continues to be strong. This is evidenced by a few things. Our traffic is positive. Our customer file continues to grow. We're seeing nice engagement in our digital and our stores channels, excited about where we're headed for the fourth quarter. The team has been busy at work all year testing and learning and really reacting to what's happening, heading into the fourth quarter, well inventoried and denim, fleece and sweaters very strong categories for us. As I mentioned, also 30 new stores to date, 6 more opening up this quarter. So we're fully prepared to compete for the fourth quarter. Robert Ball: Yes. Dana, I'll jump in here on the international side. So obviously, we continue to be really excited about the opportunities that we see for EMEA. We have invested in this region. We've got the infrastructure in place to take our brands to the market. This quarter, when you think about puts and takes, U.K. results were really strong. That's where we've been investing most to improve awareness and service our customers there. We're still in pretty early innings here in Germany and more broadly in the other European countries. We don't really have much of a presence or awareness. So we would anticipate seeing some shorter-term fluctuations here as we ramp those brands. But obviously, we see that as opportunity to go after. On the APAC side of the house, very similar dynamics here. The market is huge. Our business is relatively small. We're focused on building our brand awareness there and building a stronger presence. So again, not surprising for us to see some shorter-term fluctuations. But overall, really confident in the global opportunities that we see for our brands. Obviously committed to getting closer to those customers, deploying our playbook and ultimately taking these brands to market and growing this business longer term. Operator: Our next question comes from Corey Tarlowe with Jefferies. Corey Tarlowe: Fran, the Hollister momentum has been really impressive and it seemed like the back-to-school momentum is continuing into holiday based on what we're seeing in stores. So just curious on how you expect to continue to build on that momentum as we look ahead into 2026. Fran Horowitz-Bonadies: Corey, yes, wow, what a year we're having with Hollister. Congrats to that entire team, super excited to grow the business another 16% on last year's 14%, the tenth consecutive quarter of growth. We are seeing balanced growth, Corey, across genders, across categories. We're seeing our AUR growing on lower discounts. The customer file is growing. Our traffic is strong. Most importantly, we're holding our inventory tight, so we can really Read & React to the business. We've got great momentum heading into holiday seasons. Honestly, there's almost every category is working, which is super, super excited. I'm sure you saw the announcement yesterday, this Taco Bell partnership for Cyber Monday, we're excited about. So lots of good things happening as we head into the fourth quarter. Corey Tarlowe: That's great. And then just a follow-up for Robert. How best to think about traffic versus ticket as we head into holiday? And then any comments on what that could mean for next year as well? Robert Ball: Yes. I mean, Corey, so across our brands, when we think about sort of tickets, I guess touching on tickets real quick, haven't taken any sort of meaningful tickets. We've been talking about this for a couple of quarters now through the holiday season, it's a nice interplay as you think about this holiday season, the best way to drive traffic and to engage with that consumer is going to be through promotions and pricing. So our tickets are pretty stable. We have started to think through and take tickets here post-holiday. So you'll start to see some ticket increases across the assortment here with spring deliveries. But the good news is the AURs are growing. We made sequential improvement from spring into fall across actually both brands, Hollister and A&F and we're seeing nice positive traffic. So traffic is growing across both Hollister A&F and across channels, which is great to see, and AURs are headed in the right direction. So customer files are growing, customers are engaged. Our teams are locked in with those customer bases. We've got the right inventory here in our stores to compete for the holiday. So we're excited to push through into Q4. Operator: Our next question comes from Matthew Boss with JPMorgan. Matthew Boss: So Fran, at the Abercrombie brand, could you speak to the cadence of trends that you saw over the course of the third quarter and elaborate on trends that you're seeing so far in November? And then Robert, could you speak to the composition of inventory across both brands and gross margin puts and takes to consider for the fourth quarter? Robert Ball: Yes. So, I'll jump in here. So we obviously had a really strong third quarter, delivering our 12th consecutive quarter of growth, reaching the top end of our guide. Abercrombie, obviously, sequential improvement here. Hollister continues to grab share with that customer. We're excited about the momentum that we're carrying into Q4. In terms of the outlook, I think we're being reasonable, responsible here. We're happy with how the quarter has started. But as you know, Matt, all the volumes ahead of us here, and we're ready to compete. As it relates to the inventory side of the house, inventory is in good shape, up 5% year-over-year at cost with tariffs being about 3% of that. Units are pretty clean here and in control at up 1%, you know how we operate. We're going to keep units tight here and aligned with our forward growth expectations by brand. We didn't provide a brand breakout, but as you'd expect, Hollister units are up more than the A&F units. And again, both brands are positioned to chase to close out the year. So we feel good about where we sit from an inventory standpoint. On the margin front, gross margin puts and takes here, down about 260 basis points year-over-year in Q3. 210 basis points of that is tariffs. We did see a benefit from freight. It was a smallish benefit from freight and AUR. And then we had a couple of offsets from third-party channels and some inventory reserves to keep ourselves clean headed into holiday. So that's Q3. And then Q4, we'll see some of those themes continue, Matt. You'll see about 200 -- or about 360 basis points of impact from tariffs from that roughly $60 million. And then the freight tailwind, as we've been talking about for the past couple of quarters will continue here, and you'll see about 150 basis points of tailwind here for Q4. And then you know how we operate from an AUR standpoint. We've been on this great multiyear journey of AUR growth here. We had a great holiday last season, so we're going to come into the fourth quarter assuming AURs hold. So assuming AUR is flat here as we think about the go forward. Operator: Our next question comes from Marni Shapiro with the Retail Tracker. Marni Shapiro: Congratulations on another great quarter, best of luck for the holidays in case I forget. Can you talk a little bit about the collaborations you've been doing, the NFL, the NCAA, but you also have Kemo Sabe you did crocs. I'm curious, are these all global collaborations? Or are these specific to the U.S.? And if they're not global, will you do global? And as we think about the brands going forward into '26, I think these pops of excitement are fun. Are they bringing new customers into your store? And should we see an increase or similar cadence into '26? Fran Horowitz-Bonadies: Marni, the clubs are interesting. Our goal with our collaborations, honestly, is a real authentic branding moment. You know we talked about this a lot. We stay close to our customer and we listen to them, what's important to them, what's happening in their life moments. That's how we make these decisions to do these collaborations, so they are planned accordingly. . The NFL has been very exciting. Yes, it's definitely bringing in new customers. Our goal with that with the partnership was about brand awareness and customer acquisition. There's a big crossover with their fandom and our customer base, and we listened to the customer. They told us several years ago how important football fandom was to them, and we took that and tested our way into it and have seen a nice success with it. Kemo Sabe is another great example. Western was happening. Our consumer was responding to it. We went to an authority in the business and made a terrific collaboration. The Taco Bell, we're super excited about for Cyber Monday. So as far as 2026 goes, we will continue to listen to our customer. We'll look for authentic moments to make sure that we stay close to them, and we'll continue on this journey. Scott Lipesky: Marni, it's Scott. Just to add on here. It really speaks to where the brands are today. Each brand is in such a strong position, which is enabling us to partner with other strong and great brands. So like Fran said, it's a great way to authentically connect to our customers and lots more ahead and it's been fun for the brands. Operator: Our next question comes from Alex Straton with Morgan Stanley. Katherine Delahunt: This is Katy Delahunt on for Alex Straton. Just thinking about the Abercrombie banner, I know you've all talked about sales growth being about flat for the fourth quarter. But what is the time line you're thinking about for return to sales growth and then even comp as well? Robert Ball: Yes. So Katy, it's Robert. So obviously, delivering sequential improvement here in Q3, that's important for us. The team has been focused on that customer. We're seeing improved product execution. Inventory is clean. And as Fran mentioned, we're placing our bets here for the holiday here in sweaters, fleece, denim. So we're happy about where the brand sits, heading into holiday. Marketing is resonating new collaborations that we just talked about with Marni here earlier. Those are great brand moments. They're driving traffic. Our customer file is growing. We've got strong engagement across both stores and DTC platforms here. So we're excited about this holiday season. We're aiming to continue to progress here, hold that brand flat against last year's record, which sets us up well for next year. Operator: Our next question comes from Mauricio Serna with UBS. Mauricio Serna Vega: Great. First, on the marketing front, could you elaborate a little bit more about what you're doing across each brand, the plans for marketing this quarter, as you mentioned in the guidance for Q4 that assumes that there's more investment happening. And then maybe on the Abercrombie brand performance in Q3, could you break down like how the comps reflected AUR versus units or total sales? That would be very helpful. Robert Ball: Yes, Mauricio, let me jump in here real quick. Obviously, I'm not going to share a ton in terms of our specific marketing plans. We've got some exciting collaborations that we either have announced in terms of like Taco Bell and you'll see the campaigns kind of continue as we move through the holiday time period. It's been effective. Our traffic is up, as we've mentioned a couple of times. We're pretty intentional with our marketing here. We're obviously focused on our brand building, driving customer engagement and ultimately supporting both near term and long term. So it's not all just what are we going to see this quarter, but we're really building these brands for the long-term growth. Obviously, looking at performance as we work to optimize that spend and where we see value, we're going to lean in. And we have 2 strong healthy brands, both exactly where we want them to be, and so we're going to keep our foot on the gas here. As it relates to A&F, Q3 performance, you heard us talk about comps there, the down 7%. AUR was sequentially improved. So we did see improvement there. So if you think about the KPIs and the puts and takes, we've seen traffic on the positive side. AUR was still down, but sequentially improved here from the first half into the third quarter. And then we had a little bit of pressure here on conversion as well, but conversion also headed in the right direction. So nice to see improvements in conversion, improvements in AUR and continued engagement from our customers with positive traffic. Operator: Our next question comes from Rick Patel with Raymond James. Rakesh Patel: Congrats on the progress. I was hoping you could double-click on the expectations around SG&A. I know marketing is going to increase, but you touched on being able to mitigate some of that pressure through other areas. So if you can expand on that, that would be great. And then second, just on comps, wondering if there's any variability performance to flag in the U.S. due to the weather or any regional differences. Robert Ball: Yes. So quick on the SG&A side of things, yes, we'll see a little bit of increased marketing investment year-over-year. We've obviously been leaning into this throughout the first 3 quarters of the year. That will continue, but at a slightly slower clip here in Q4. Q4, obviously, with the sales growth, you're going to see some expense leverage on the G&A side of the house. We've been delivering that throughout the entire year. And given the midpoint of our guide, we wouldn't expect a ton of leverage or deleverage in total at the midpoint of that 4% to 6%. We'll see as we have the rest of the -- as we have all year, as we outperform on the top line, you might see some leverage roll through. But again, we're going to be balanced in our investment approach and where we see opportunities to continue to invest in this business for the longer term, we will. Nothing really to call out from a regional standpoint. We've got a really broad store fleet. So weather in one area, it kind of offsets across the board. Might there be a day or a week here in there that you start to see little blips based on weather events, when you think about the broader quarter, it kind of all works itself out, and it's been pretty consistent for us across the regions. Operator: Our next question comes from Janine Stichter with BTIG. Janine Hoffman Stichter: Congrats on the progress. One more question about Abercrombie. It sounds like a lot of the improvement sequentially was led by Women. Can you just elaborate on what's going on in the Men's side. If I recall, the comparisons there maybe weren't as challenging as what you had in the first half with Abercrombie. So just help us understand what's going on with that side of the business? Fran Horowitz-Bonadies: Janine, it's Fran. Yes, led by Women's but also seeing nice sequential improvement in Men's as well. Again, inventories are clean, super excited about where we are for the fourth quarter. Team has been busy at work, testing and learning all season, so -- or all year pardon me, heading into the fourth quarter to make sure our inventories are where we want them to be, focused on categories like denim, fleece, and sweaters. So we feel good about the fourth quarter, heading into a big week, right, excited for seeing all the excitement out there for Black Friday and ready to compete. Janine Hoffman Stichter: And then maybe one for Robert, just on the tariffs, I think you said $60 million in Q4 net of mitigation. Any initial thoughts on just how to think about that in the first half of next year as you proceed with more mitigation efforts? Robert Ball: Yes. So we've talked quite a while, Janine, around our sourcing footprint. We've been obviously at work at this for quite a long time, starting way back in tariffs, 1.0. We've got a really well diversified sourcing footprint here. We source from over a dozen countries, which obviously gives us a benefit both from a cost negotiation standpoint as well as speed to market, which is obviously core to our model here. I think it's important for us to take a step back real quick and think about how we're entering this next chapter of tariffs. We're coming at this from a position of strength. We're coming off of 15% operating margins last year to go along with record net sales. The teams have obviously been active. We've got a proven playbook here. So they're leveraging the playbook. They're looking at country of origin footprint as well as finding expense efficiencies. And we've touched on this earlier. But while we haven't moved tickets broadly, through the holiday we are taking targeted price increases here for the spring. So that inventory will start delivering here post-holiday. We've done all of that as we've kind of been navigating 2025, and we've delivered record sales for the first 3 quarters of the year. We're positioned to do the same for the fourth quarter. And we've continued to invest in this business and return cash to shareholders. So bought back 350 million shares year-to-date, on track to do another $100 million here in the fourth quarter. So we're doing all this, all while delivering 13% to 13.5% operating margins despite this 170 basis points of tariff impact. So the company is strong. We feel like we're operating and executing at a high level. We'll detail a lot of the components out and the magnitude of some of the stuff for 2026 when we get into our next call. But suffice it to say that we're confident in our ability to navigate this environment. And obviously, our goal is to meaningfully offset these tariff headwinds longer term. Operator: [Operator Instructions] Our next question comes from Janet Kloppenburg with JJK Research Associates. Janet Kloppenburg: Congratulations on the upside. I wanted to ask a few questions. I'll give them to you right now. The tariff impact will be greater in the first quarter than the fourth quarter, Robert? I'm not sure on that. And the price increases, when do you expect those to be complete, like what we see a big bump in the first quarter and then you'll be done. Maybe you could talk to that cadence. And on cadence plan, I thought that the assortments that Abercrombie started to get better in mid-October and continued. And I'm wondering if you saw some response from the consumer on that unless I'm wrong. And then the fourth question is just on promo levels. What you saw in the third quarter year-over-year, what you experienced in the third quarter? And what's your thinking about for the fourth quarter? Robert Ball: All right, Janet. Fran Horowitz-Bonadies: Where do you want to start, Robert? Do you want to start to take the tariff one? Robert Ball: Yes, let's just keep the tariff conversation going here a little bit. So haven't quantified anything related to 2026. But as you think about how this is going to cadence out Janet, we would expect that a lot of our mitigation tactics, which we've been working at for the last 9 months here. Those will start to take hold heading into 2026. So the hope here and our confidence level and obviously, the pricing adjustments that we've made, which I guess is your second question. Those will start to show up here with spring deliveries. So think late December and into January, you'll start to see those tickets go up. And that will just kind of work through as the assortments and the newness flows through into the quarter. As you think about vendor negotiations and all those pieces and parts, that will also start to impact the first quarter here in 2026. So expectation would be that we would see some relief off of that Q4 tariff headwind of 360 basis points. Janet Kloppenburg: Yes, promos, and then Fran can talk to the A&F assortment. Fran Horowitz-Bonadies: Go ahead, finish the promos. Robert Ball: Yes. So from a promo standpoint, we feel good about the cadence that we've been operating under. We've obviously got a track record here of pulling back on promotions and improving AURs here wherever we can. AURs did see sequential improvements from front half into back half across the brands. Hollister is continuing to grow units on lower discounting with higher AURs. So headed into the fourth quarter, we're confident in our promotional plans. We've got the flexibility, and we've got the reactivity to adjust to demand as we see it come through. We're looking to hold those AURs flat for Q4. And like we do always, we'll come in every day. We'll see if we can pull back on a day of promos here, go a little bit shallower there. But it's been a nice formula for us with this multiyear AUR growth, and we're just going to keep -- we're going to keep executing that playbook. Fran Horowitz-Bonadies: And then just real quick on the last piece of that question. So I'm very excited to have announced that we made the progress that we committed to at the beginning of the year that we're seeing sequential improvement in Abercrombie, and that's really across the board in categories. So we're heading into the fourth quarter. We've committed to having clean inventories, and that's where we are. We feel really well positioned, Janet, for the fourth quarter. We are expecting to be -- our goal is to be approximately flat for the fourth quarter. That's on top of a record fourth quarter for last year. So we're happy with the start. The customer is resilient. Our file is growing, as I've said before, our traffic is positive, and we're ready to compete for the fourth quarter. Janet Kloppenburg: You're talking about A&F, Fran. Fran Horowitz-Bonadies: Janet, I'm talking total company, but yes, with A&F specifically, we committed to sequential improvement, and that's what we have delivered with a goal of approximately being flat for the fourth quarter. Janet Kloppenburg: Do you feel like the challenges that you faced in merchandising in the first half at A&F are now behind you? Fran Horowitz-Bonadies: Yes. We committed to getting clean. The opportunities in the first half, which we talked about on both of those calls are really the opportunity that the inventory was much more balanced between sale clearance and regular price. That was something that we didn't really have in 2024. And that's what drove the reduced AUR. As Robert mentioned, we've made sequential improvement in the AUR as we continue to see the customer responding to the newer product. Operator: There are no further questions at this time. I'd like to turn the call back over to Fran for any closing remarks. Fran Horowitz-Bonadies: All right. Thanks, everyone. Just wishing you all a happy holiday season, and we look forward to updating you soon. Operator: Thank you for your participation. You may now disconnect. Everyone, have a great day.
Operator: Good morning, and welcome to the PennantPark Floating Rate Capital's Fourth Fiscal Quarter 2020 Earnings Conference Call. Today's conference is being recorded. [Operator Instructions]. It is now my pleasure to turn the call over to Mr. Art Penn, Chairman and Chief Executive Officer of PennantPark Floating Rate Capital. Mr. Penn, you may begin your conference. Arthur Penn: Thank you, and good morning, everyone. Welcome to PennantPark Floating Rate Capital's Fourth Fiscal Quarter 2025 Earnings Conference Call. I'm joined today by Rick Allorto, our Chief Financial Officer. Rick, please start off by disclosing some general conference call information and include a discussion about forward-looking statements. Richard Allorto: Thank you, Art. I'd like to remind everyone that today's call is being recorded and is the property of PennantPark Floating Rate Capital. Any unauthorized broadcast of this call in any form is strictly prohibited. An audio replay of the call will be available on our website. I'd also like to call your attention to the customary safe harbor disclosure in our press release regarding forward-looking information. Our remarks today may also include forward-looking statements and projections. Please refer to our most recent SEC filings for important factors that could cause actual results to differ materially from these projections. We do not undertake to update our forward-looking statements unless required by law. To obtain copies of our latest SEC filings, please visit our website at pennantpark.com or call us at 212-905-1000. At this time, I'd like to turn the call back to our Chairman and Chief Executive Officer, Art Penn. Arthur Penn: Thanks, Rick. I'll begin today's call with an overview of our fourth quarter results and recent strategic initiatives, including the $250 million portfolio acquisition and our new joint venture, PSSL, I'll then share our perspective on the current market environment and how PFLT is positioned for continued growth. Rick will conclude with a detailed review of the financials, and then we'll open up the call for Q&A. For the quarter ended September 30, core net investment income for the quarter was $0.28 per share. We previously announced the acquisition of a $250 million portfolio and the formation of a new joint venture with an initial targeted portfolio of $500 million. These initiatives underscore our focus on enhancing PFLT's earnings power through scale diversification and disciplined capital deployment, key pillars of our long-term growth strategy. The portfolio acquisition adds high-quality well-known assets, that are projected to increase net investment income by $0.01 to $0.02 per share on a quarterly basis. The JV with Hamilton Lane, a respected global investor enhances our funding sources and provides a scalable platform for future growth. The PSSL 2 JV began investing this month and closed a $150 million revolving credit facility, which bears interest at SOFR plus 175 basis points. The credit facility has an accordion feature, allowing total commitments to increase to $350 million. Our run rate NII is projected to approximate our current dividend as we ramp the PSSL 2 portfolio. Our game plan is to grow PSSL 2 to be in excess of $1 billion in assets similar to our existing joint ventures. As we achieve this game plan, our NII should be well in excess of our current dividend. Regarding the current market environment for private middle market lending, we are encouraged by a steady increase in transaction activity, which we expect will translate into a higher loan origination volumes in the quarters ahead. Additionally, we continue to provide additional capital to many of our existing portfolio companies as they execute their respective growth initiatives, demonstrating the depth and resilience of our origination platform. We are optimistic that the increase in transaction activity will also result in opportunities to exit some of our equity co-investments and rotate that capital into new current income-producing investments. We believe the current environment will favor lenders with strong private equity sponsor relationships and disciplined underwriting, areas where PFLT has a clear advantage. We continue to see opportunities to deploy capital into core middle market companies where leverage is lower and spreads are higher than in the upper middle market. In the core middle market, the pricing on high-quality first lien term loans is SOFR plus $4.75 to $5.25. Leverage is reasonable, and we continue to get meaningful covenant protections while the upper middle market is primarily characterized as covenant light. Turning to our current portfolio. We continue to maintain what we believe is one of the most conservatively structured portfolios in the direct lending industry. This is evidenced by having among the lowest PIK percentages in the industry at 1.8% for the quarter. As of September 30, our portfolio's median leverage ratio through our debt security was 4.5x and the portfolio's median interest coverage was 2x. For new platform investments made during the quarter, the median debt-to-EBITDA was 4.4x. Interest coverage was 2.3x and the loan-to-value was 44%. We had three investments on nonaccrual status and total nonaccruals represent only 0.4% of the portfolio at cost and 0.2% at market value. These strong credit metrics reflect the rigor of our underwriting process and the discipline of our investment approach. We continue to believe that our focus on core middle market provides us with attractive investment opportunities where we provide important strategic capital to our borrowers. The PennantPark platform has a demonstrated track record of value creation through the successful financing of growing middle market companies across five key sectors. These sectors in which we possess deep domain expertise, enabling us to ask the right questions and consistently deliver strong investment outcomes. They are business services, consumer government services and defense, health care and software technology. These sectors have been recession resilient, tend to generate strong free cash flow and have a limited direct impact to the recent tariff increases and uncertainty. Core middle market companies, typically those with $10 million to $50 million of EBITDA, operating below the threshold of broadly syndicated loan or high-yield markets. In the core middle market, because we are an important strategic lending partner, the process and package of terms we receive is attractive. We have many weeks to do our diligence with care. We thoughtfully structured transactions with sensible credit statistics meaningful covenants, substantial equity cushions to protect our capital, attractive spreads and equity co-investment. Additionally, from a monitoring perspective, we received monthly financial statements to help us stay on top of the companies. Regarding covenant protections, while the upper middle market has seen significant erosion, our originated first lien loans consistently include meaningful covenants that safeguard our capital. Our credit quality since our inception over 14 years ago has been excellent. PFLT has invested $8.4 billion and 539 companies, and we have experienced only 25 nonaccruals. Since inception, PFLT's loss ratio on invested capital is only 11 basis points annually. As a provider of strategic capital, he fuels the growth of our portfolio companies. In many cases, we participate in the upside of the company by making an equity coinvestment. Our returns on these equity co-investments have been excellent over time. Overall, for our platform from inception through September 30, we've invested over $596 million in equity co-investments and have generated an IRR of 25% and a multiple on invested capital of 2x. As of September 30, our portfolio grew to $2.8 billion, up from $2.4 billion in the prior quarter. During the quarter, we continue to originate attractive investment opportunities and invested $633 million and 11 new and 105 existing portfolio companies at a weighted average yield of 10.5%. As of September 30, the PSSL 1 portfolio totaled $1.1 billion and during the quarter, invested $89 million in 4 new and 14 existing portfolio companies. We believe that the increase in scale of PSSL's balance sheet will continue to drive attractive mid-teens return on invested capital and enhanced PFLT's earnings momentum. From an outlook perspective, our experienced intelligent team and our wide origination funnel are well positioned to generate strong deal flow, our mission and goal or a steady, stable and protected dividend stream, coupled with the preservation of capital. Everything we do is aligned to that goal. We seek to find investment opportunities in growing middle market companies that have high free cash flow conversion. We capture that free cash flow primarily in first lien senior secured instruments, and we pay out those contractual cash flows in the form of dividends to our shareholders. With that overview, I'll turn it over to Rick for a more detailed review of our financial results. Richard Allorto: Thank you, Art. For the quarter ended September 30, GAAP net investment income and core net investment income were both $0.28 per share. Operating expenses for the quarter were as follows: interest and expenses on debt were $25.8 million, Base management and performance-based incentive fees were $13.4 million. General and administrative expenses were $2 million and provision for taxes was $0.2 million. For the quarter ended September 30, net realized and unrealized change on investments, including provision for taxes was a loss of $10 million. As of September 30, NAV was $10.83 per share, which is down 1.2% from $10.96 per share last quarter. As of September 30, our debt-to-equity ratio was 1.6x, and our capital structure is diversified across multiple funding sources, including both secured and unsecured debt. Subsequent to quarter end, we sold $118 million of assets to the PSSL 1 joint venture and $191 million of assets to the new PSSL 2 joint venture. We used the net proceeds from these sales to pay down our revolving credit facility and reduce our debt-to-equity ratio to 1.4x and which is at the lower end of our target range of 1.4x to 1.6x. As of September 30, our key portfolio statistics were as follows: the portfolio remains well diversified, comprising 164 companies across 50 industries. The weighted average yield on our debt investments was 10.2% and approximately 99% of the debt portfolio is floating rate. PIK income equaled only 1.8% of total interest income. We have three nonaccruals, which represent of the portfolio at cost and 0.2% at market value. The portfolio is comprised of 90% first lien senior secured debt second lien and subordinated debt, 2% in equity of PSSL and 7% in equity co-investments. The debt to EBITDA on the portfolio is 4.5x and interest coverage was 2x. Now let me turn the call back to Art. Arthur Penn: Thanks, Rick. In conclusion, I'd like to thank our exceptional team for the continued dedication and our shareholders for their trust and partnership. We remain committed to delivering strong performance, preserving capital and creating long-term value for all stakeholders. That concludes our remarks. At this time, I would like to open up the call to questions. Operator: [Operator Instructions]. We will take our first question from Robert Dodd with Raymond James. Robert Dodd: I guess, on the portfolio acquisition, particularly, I mean how -- I mean, I guess how did that come about? And secondly, are there more opportunities like that? And what way do you think that is you obviously get a pool of assets there, you don't get to pick and choose, I presume. So I mean what's the value of an acquisition which was a big lump versus deploying the capital into individual investments? Arthur Penn: Thanks, Robert. Just to take a step back. That was another joint venture that we had with a third-party with all of the same assets in self-originated assets that we originated Actually, those were originated a couple of years ago, so the spreads are high. We know the portfolio very well. So that was really just an acquisition of more of the same type of assets that we already have in PFLT and in fact, many of the same assets that we already have in PFLT. Robert Dodd: Got it. Got it. On the -- and then just to the point on the market, I mean, it does seem like it's ramping up. Are you seeing any kind of bifurcation. I mean, I think, obviously, logistics companies have been an issue post-COVID, not you, right? I mean -- so are you seeing any kind of application about what you would like to do or what is coming to market in terms of still some things having COVID handovers or these handovers or any thoughts there? Arthur Penn: Yes. So look, logistics, as you mentioned, is an area that's still dealing with post-COVID. There is a general reversion to the mean that we're seeing throughout the economy where we're seeing softness and this has been broadly reported in the media. The consumer -- the average consumer is relatively soft. Inflation has remained high, and the tariffs did not help that. So the average consumer in America is a little soft, which is kind of in the back of our mind as we underwrite credit. We have very little amounts in consumer brands. We do have consumer services, consumer services, we tend to have are more related to the home, which generally is hanging in there. pretty well. But that's what we think about. The other area is that we focus on government services, defense, health care, those remain pretty strong. Robert Dodd: Got it. And on that, like -- you do have some good exposure to the government and contracting, et cetera. Is that the shutdown of which obviously went on a while? Did it have any impact on any of the portfolio companies? Arthur Penn: We have very little exposure to so-called civilian government activities. It's more defense, intelligence things of that nature where the shutdown did not really have an impact. So we're no pun intended, we're well defended there. Operator: We will take our next question from Brian McKenna with Citizens. Brian Mckenna: Good morning, Art and Rick. I appreciate the disclosure around the $310 million of assets that were sold to both JVs post quarter end. I'm curious, when were these loans initially originated? And I'm just trying to figure out the NII contribution from these assets in fiscal 4Q, and then really the starting point for NII in fiscal 1Q, given these sales, the scaling of the second JV as well as the full quarter run rate from the portfolio acquisition. Arthur Penn: Yes. So the -- I think we sent out a press release when we did the portfolio acquisition. I think it was kind of mid-quarter. So we did not get a full quarter of ramp from those assets that we bought the $250 million portfolio. So in our comments, when we said full quarter, it should add about $0.01 to $0.02 per share of NII for a full quarter of those assets. The JV starts to become much more accretive as it scales. So day 1, it's not really accretive. But as it gets to $500 million, $750 billion, $1.2 billion like the other JVs, that's when you start to see the benefit of the scale of it, the financing that you get. You can see the returns that our other two JVs are generating the JV we have in PFLT and in the JV we have in PNNT. If you model a 15% return on that junior capital and you deploy a reasonable amount in that in the Hamilton Lane JV, we're 75% of the junior capital. It starts to become in a very, very attractive addition to the NII. But it's it probably takes a year or 2 before you start to get the benefits of that ramp. We certainly want to ramp it, but we also want to be careful and conservative along the way. And make sure we're putting really solid assets into that joint venture. So the NII contribution for that is probably over, call it, a year depending on deal flow and all of that. So I don't know if I answered your question with that, Brian, but please continue to ask if I didn't. Brian Mckenna: Yes. No, that's helpful. I appreciate it. And then I guess just a follow-up on the dividend. I think in the prepared remarks, you said as the second JV scales NII should be well in excess of the dividend. And so I appreciate to your prior comments, it's going to take a year or 2 to full year ramp. But thinking about that comment in excess or well in excess of the dividend, I mean is that contemplating the forward curve? Is that contemplating any other kind of credit quality changes? And then what other kind of core assumptions are in that? Arthur Penn: Yes. Look, we can run models with each other. Certainly, well in excess with the existing surfer curve, certainly the market indicates we have some room to head downward with SOFR. But I think even if you take the market's assumption of where SOFR is going to be a year out, I think we should -- based on our numbers, and we can compare models, I think we're still covering the dividend reasonably well. Operator: We will take our next question from Doug Harter with UBS. Douglas Harter: Thanks. Can you just talk about kind of where you're seeing new loan spreads and sort of kind of any stabilization there? And then how that compares to what you're seeing on new financing costs? Arthur Penn: Yes. So I think we talked about our new JV guide credit facility at the SOFR plus 175. So that's kind of our most recent comparable kind of loan that we can access. I think we said in our stated remarks that we've seen it kind of in the 4.75% to 5.25% range on average in our world now our world a little bit lower risk, i.e., our average debt to EBITDA is in the mid-4s, we're not stretching for -- we're not stretching for yield. Our loan to values are kind of 40-ish percent. So in our box, we're okay taking we're okay taking a little lower yield if the credit is really, really solid. So we will do a $475 million or $500 million. If we really feel good about the credit, the and the value and the low leverage. Again, that shows up in the PIK percentage 1.8%, we're probably among the lowest in the industry in terms of the amount of PIK Obviously, if you have higher leverage in your book, whether it's 6x, 7x ARR loans, whatever you want to call them, pick is more of a requirement because of the higher leverage. Operator: We will take our next question from Arren Cyganovich with Truist Securities. Arren Cyganovich: Following up on the prior questions. The portfolio acquisition boosted leverage to around 1.6x and then subsequently to that, so it went back down to 1.4x. Is that 1.4x? Does that run rate cover the dividend? And how much if you were just to exclude PSSL, does that cover the dividend? I'm just trying to kind of have the puts and takes and put those to your comments. Arthur Penn: Yes. Look, we're happy to go through model inputs and such. Our general leverage range is 1.4x to 1.6x. So as you saw, sometimes we'll take it up to 1.6x, we'll move assets into our two JVs. We'll get down to 1.4x. And so I guess if you wanted to model 1.5x kind of middle of that range. And yes, if you kind of model -- our belief is if you model 1.5x, if you grow the JV over time, we should be able to easily cover our dividend. And even if you took a SOFR reduction and put that and we believe so. So we can go through the -- we can go to model with you and go through scenarios with you, but that's -- as we look at the scenarios of ramping the second JV. We do hope we do get some equity rotation. As M&A happens, we believe we should be able to get some equity rotation, which help out a lot if you take this joint venture and you model it out similar to our other two joint ventures, that's kind of where we land. Arren Cyganovich: Got it. That's helpful. And then the credit quality has been solid, really for the industry. Here, you have some small one-offs here and there. Maybe you could talk a little bit about the strength of your underlying portfolio companies and what you're seeing in terms of trends and average EBITDA and revenues for your portfolios? Arthur Penn: Yes. I don't know if we put it in prepared remarks, we are seeing kind of double-digit growth in revenues and probably single-digit growth and mid-single-digit growth. Again, kind of what we chatted about earlier, it's industry and company specific, of course. Logistics we talked about, there's a couple choppier credits there. we're focused a lot on the consumer and kind of how the consumer is faring in this environment. So we're focused on that. By and large, the portfolio is healthy. So to have all the names that we had well over 100 and have a handful of choppier names is totally expected. It's what we model. Of course, we're -- any of these portfolios, you're going to have a handful of names that are one way share perform experiencing issues. Sometimes they rebound, sometimes they don't. But we think the number of choppier credits is relatively minor at this point. And the watch list of things that we're kind of looking is nothing really unusual about what's going on right now. We're not seeing any systemic issues with credit at this point in the economy or direct lending at this point in the economy. It's kind of the same old story here. Operator: We will take our next question from Paul Johnson with KBW. Paul Johnson: What happened with your investment in Bilight quarter-over-quarter? It looked like maybe there was a little bit of a payoff there some sort of realization. But just curious what happened in that company? Arthur Penn: Yes. There was a dividend recapitalization and we are in the equity, that's one where we have an equity co-invest. There was a realized gain of about $0.04 a share. Paul Johnson: And that's $0.04 in terms of dividend income this quarter? Or is that just the realized gain that was taken? Arthur Penn: That was not an income element. That was a NAB element. So we had some realized gains. We had some realized losses. Walker Edison was the big realized loss that was already written down. It was unrealized, it became realized something called LAV gear was realized and when through a restructuring. So it was a realized $0.05. So Walker Edison was realized $0.12 per share LAV gear was realized $0.05 per share and then this Bilight was a realized positive of $0.04 a share. Operator: We will take our next question from Christopher Nolan with Ladenburg Thalmann. Christopher Nolan: Is it correct here that the EBITDA coverage was 4.5x, 4.4x? Arthur Penn: 4.4x would be the debt to EBITDA, yes. Christopher Nolan: Am I correct that it sort of seems like either the leverage is going down on these portfolio companies or the EBITDA is going up? I presume your EBITDA is going up. Is that a fair assumption? Arthur Penn: Well, it could be both. It depends on the company as we just said, EBITDA is going up a bit in the portfolio. And also if we're underwriting correctly, the companies are deleveraging and paying debt down, which is -- which, of course, is our goal. We'd love to see pay down and -- and then on the new deals, the new deals that come in are again relatively low leverage and kind of in the low to mid 4s. Christopher Nolan: Okay. And then on the stock price is trading 17% below book. Any consideration in terms of buybacks? Or does all the joint ventures sort of restrict your abilities to do that given the leverage ratio? Arthur Penn: The Board of Directors always considers all options including buybacks, insiders or continual buyers of our portfolios, both public funds and private funds. So it does appear to be a good value right now. Operator: There are no further questions at this time. I will now turn the conference back to Mr. Penn for any additional or closing remarks. Arthur Penn: Thanks, everybody, for your participation in this Thanksgiving season. We are certainly grateful for the trust that our shareholders have given us. We wish everyone a terrific Thanksgiving and holiday season, and we'll speak to you in early February. Operator: This concludes today's call. Thank you for your participation. You may now disconnect.
Operator: Good morning, and welcome to the Kohl's Corporation Third Quarter 2025 Earnings Conference Call. [Operator Instructions] As a reminder, this conference call is being recorded. I'd now like to turn the call over to Trevor Novotny, Director of Investor Relations. Thank you. Please go ahead. Trevor Novotny: Thank you. Certain statements made on this call, including those regarding our projected financial results, business outlook and future initiatives are forward-looking statements. These statements are based on current expectations and assumptions and are subject to certain risks and uncertainties that could cause Kohl's actual results to differ materially from those projected. These risks and uncertainties include, but are not limited to, the factors described in Item 1A of Kohl's most recent annual report on Form 10-K and as may be supplemented from time to time in Kohl's other filings with the SEC, all of which are expressly incorporated herein by reference. Forward-looking statements relate to the date initially made, and Kohl's undertakes no obligation to update them. In addition, during this call, we may refer to certain non-GAAP financial measures. Please refer to the cautionary statement and reconciliations of these non-GAAP measures included in the investor presentation filed as an exhibit to our Form 8-K, as filed with the SEC and available on our Investor Relations website. Please note that this call will be recorded. However, replays of this call will not be updated. So if you are listening to a replay, it is possible that the information discussed is no longer current, and Kohl's undertakes no obligation to update such information. With me this morning are John Schlifske, our Independent Chair of the Board; Michael Bender, our Chief Executive Officer; and Jill Timm, our Chief Financial Officer. I will now turn the call over to John. John Schlifske: Thank you, Trevor, and thank you for joining us this morning. I will be providing some brief introductory remarks, and then I'm going to turn it over to Michael and Jill to go over our third quarter performance, and then we'll take some Q&A. As announced yesterday, the Board has appointed Michael Bender as Chief Executive Officer of Kohl's. Michael is a seasoned retail veteran who has a deep understanding of Kohl's business, serving as a Board member since 2019 former Chair of the Board and most recently as Interim CEO since May. In addition to his Kohl's experience, Michael brings over 30 years of senior leadership experience across the retail and consumer goods industries. Over the last 6 months, the Board has gone through an extensive search process to identify our new CEO, and we could not be more thrilled to have Michael as the next leader of this company. There's been a lot of change over the last year at Kohl's, and Michael has proven to be an effective leader, fostering a strong culture and providing stability through the transition. Additionally, during this time as interim CEO, Michael has made important strategic decisions addressed key areas of opportunities and helped deliver progressive improvements to the business. Kohl's has a solid foundation for the future, boasting over 1,100 stores in a vast digital platform that serves more than 60 million customers each year. We have the utmost confidence that Michael is the right leader for this company, and we're excited about the substantial opportunity that can be realized under his leadership. On behalf of the Board, I'd like to congratulate Michael on his new position. We look forward to supporting him and the management team in this next chapter. With that, I'll now turn the call over to Michael. Michael Bender: Thank you, John, and good morning, everyone, and thank you for joining Kohl's third quarter earnings conference call. I'm honored to assume the role as Chief Executive Officer of Kohl's, and I would like to thank John and the Board for giving me the opportunity to lead this great company. Since I joined the team in May, I've been deeply impressed with the Kohl's team, their resilience and their motivation to win. My commitment is to lead this organization, our associates and our customers. Every day, Kohl's has the privilege of serving millions of customers, and we will continually strive to enhance their experience and meet their evolving needs. I'm excited about the opportunity that lies ahead and look forward to repositioning Kohl's for future success. Now during our call today, I'd like to discuss three items with you. First, discuss our third quarter performance; second, highlight the progress we're making against our 2025 initiatives. And lastly, give a brief overview of how we are positioned for the Q4 holiday season. Let me start with our third quarter results. We are pleased as we delivered both top line and bottom line performance ahead of our expectations for the third consecutive quarter. These results directly reflect the progress we're making against our 2025 initiatives, which are building momentum and continuing to resonate with our customers. While we are encouraged with the progressive improvement we're making, we want to acknowledge that this performance is not representative of where we aspire to be. Our team is working diligently to further execute against these 2025 initiatives to deliver quality products, great value and a frictionless experience to our customers. Looking deeper into our top line performance, our comparable sales performance continued to improve as we ran down 1.7% in the third quarter. We started the quarter with a better-than-expected performance in August and back-to-school season. However, in September, we experienced a slowdown as we faced unseasonably warmer weather impacting our fall seasonal businesses. October was the strongest month as we delivered a positive 1% comparable sales performance. The quarter was led by a strong digital performance, up 2% versus last year. As Jill will discuss in further detail later in the call, the improved performance was driven by an acceleration in our transactions versus prior quarter. This was particularly notable with our Kohl's Card customer, whose sales performance improved by over 500 basis points from Q2. This demonstrates important progress we're making with reengaging our core customers. While these results are encouraging, we continue to operate in an environment where our customers are becoming increasingly choiceful as their discretionary income remains pressured. This is especially notable in our low to middle-income consumers, as well as in our younger customers. These customers are becoming increasingly savvy and are seeking more value. We expect this customer behavior to continue into the fourth quarter as we believe the macroeconomic environment will remain uncertain. This leads into the progress we're making against our 2025 initiatives. These efforts are centered around three key priorities: first, offering a curated, more balanced assortment that fulfills the needs of our customers. Next, reestablishing Kohl's as a leader in value and quality and lastly, delivering a frictionless shopping experience across our omnichannel platforms. Starting with our first initiative, offering a curated and more balanced assortment that fulfills the needs across all of our customers. By delivering an improved rebalanced assortment, we are able to serve a broader range of customers. As we have previously communicated, our focus in recent years has been around attracting a new customer which unintentionally led to not fully catering to our core loyal customers' needs. Each quarter this year, we have made meaningful improvements to our assortment offerings, which have translated to an improvement in transactions particularly from our core customers. In addition, we are pleased to report that the new assortment continues to resonate with our non-Kohl's card customers, driving a fourth consecutive quarter of positive sales growth. The category that is particularly important to this core customer and overall company performance is our women's business. Women's ran in line with company performance and experienced a significant improvement from the second quarter. This was led by positive performance in our proprietary brands, which heavily penetrated into our women's business. We continue to see the benefit from reinvesting inventory into key priority brands like Lauren Conrad, Simply Vera Vera Wang and Tek Gear. Within the women's category, we experienced an acceleration in our juniors business, which ran a positive comp in the quarter. Juniors is a pivotal component to the women's performance as it is a faster turning business and has reduced lead times on products. We saw strength in our key fall categories such as sweaters and fleece. We also benefited from the denim trend with national brands like Levi's and proprietary brands like SO. Lastly, we continue to see positive performance in Petites, as we benefit from reestablishing this category in all stores earlier this year. Building on this success, we are excited about expanding this presence next year with our proprietary brands, Lauren Conrad and Simply Vera Vera Wang, in all stores. Our men's business showed significant improvement in the quarter, running in line with company performance. This improvement from Q2 was driven by better clarity in our offering. As we enter Q4, we are continuing to make progress around clarity as receipts for our choice counts are down 10% and debt is up 5%. Customers leaned into proprietary brands, which ran a positive comp in the quarter as they looked for key brands like FLX and Tek Gear. In addition to solid proprietary brand performance, men's apparel also saw strong performance in the dress and tailored category with brands like HAGGAR and Apartment 9. Accessories continues to be a bright spot for the company with Sephora, Impulse and jewelry collectively helping to deliver positive comparable sales in the quarter. Sephora ran up 2% in the quarter with comparable sales down 1%, with solid performance in categories like fragrance and hair care from brands like YSL, Valentino and Summer Fridays. We continue to be pleased with this partnership, which delivered nearly a $2 billion business in 4 years. Sephora is outstanding at offering discovery, innovation and newness to customers and we are thrilled to announce that we will be offering MAC in 850 of our Sephora at Kohl's stores in spring of 2026. In September, we completed the rollout of 613 impulse queuing lines, establishing a presence in nearly all stores. Impulse ran up over 40% in the quarter as we continue to benefit from this white space opportunity that adds an additional unit to our customers' baskets. Jewelry ran up 10% in Q3 as we continue to gain traction in this category after we establish the destination for accessories behind Sephora. Strength in jewelry came from both fashion and bridge jewelry, as well as fine jewelry, both running positive comps in the quarter. We continue to test fine jewelry in 200 doors and believe this category will be an opportunity for us moving forward as its nonsubstitutable nature helps provide an incremental sale. Our home business showed the largest improvement in the quarter, running in line with company performance. Soft Home categories like bedding and bath outperformed with strength from new proprietary brands like Hotelier and Miryana. Small electrics continue to underperform as expected given the impact of price increases and buying quantities down based on our elasticity analysis. Lastly, footwear and kids remained challenged in the quarter. These categories remain an opportunity for us moving forward. In kids, we are looking for ways to highlight key proprietary brands like Jumping Beans and Little Co. The footwear business continues to underperform with softness coming from active footwear and boots. We expect the boots business to remain soft in Q4 as we adjusted our buys down given the pricing elasticities of this category. Dress and casual footwear showed strength in the quarter with brands like Apartment 9. Moving on now to our second initiative, reestablishing Kohl's as a leader in value and quality. What differentiates Kohl's is our ability to offer customers a blend of top national brands like Nike, Levi's and Sephora, as well as proprietary brands that are exclusive to Kohl's. This complementary brand assortment is essential to our value proposition as it enables customers to find quality, relevance and value in shopping at Kohl's. This value proposition is especially important to our core loyal customers who expect to find exceptional value when shopping at Kohl's. As our customers continue to be more choiceful and remain under pressure, we have the opportunity to meet their needs and offer more value with elevating our proprietary brands. We identified the opportunity to reinvest into our proprietary brands 1 year ago as we over-indexed into market brands, making it more challenging to find products at an opening price point. Since identifying this opportunity, we have made sequential improvement each quarter delivering a positive proprietary sales performance in the third quarter. This performance was led by brands like SO and Juniors LC and Simply Vera Vera Wang in women's and Tek Gear and FLX and men's. In addition to these well-established brands, we are seeking to find new opportunities to offer more value-oriented proprietary brands in categories like home and kids. In home, we recently launched three new brands. Hotelier, Mingle & Co and Miryana, which serve our soft home and tabletop categories. Our customers have shown positive initial reactions to these introductions, and we are excited about these brands moving forward. Building off the success of our FLX brand, which delivered another quarter of double-digit sales growth, we made the decision to expand this brand into our kids department in September. Currently, we have FLX Kids in 300 doors and are committed to expanding this to more doors next spring. As we continue to refine our balance between national and proprietary brands, we're committed to moving where our customer is leading us. The second action we took to deliver more value to our customers was through enhanced promotional strategies. Kohl's has traditionally offered incredible value to our customers through our coupon led promotional strategy. And after excluding a growing number of brands, our promotions became less impactful to our customers over recent years. This ultimately created unnecessary friction within our shopping experience particularly with our Kohl's card customers. In response to this, we identified a list of brands to be coupon eligible at the end of the first quarter. Following the success of the initial wave of brand inclusion, we made the decision to add a second wave of brands into the coupon in late August. The second wave was smaller as it included roughly 50 brands that are more digitally native. We continue to see a positive impact to our digital channel as this channel experiences elevated pricing transparency. Additionally, we are encouraged by the improvements this is generating with our core Kohl's card customers. We continue to test ways to drive customer awareness on brands that are now coupon eligible through signage and graphics. Next, I would like to discuss our last priority, which is delivering a frictionless experience across our omnichannel platforms. We're focused on creating an elevated, more consistent experience across our store fleet and on our digital platforms. To capitalize on this opportunity, we're identifying ways to optimize our store layout, increase our inspiration and restore trip assurance. We continue to see benefits after making edits to our store layout. Following some preliminary adjacency analyses, specifically with juniors and accessories businesses, we decided to move Juniors to the front of the store across from Sephora and establish an accessories pad behind Sephora. Since making these changes, both categories have shown progress. In accessories, excluding Sephora, we've seen three consecutive quarters of positive sales growth driven by initiatives like Jewelry and Impulse. For Juniors, we achieved a positive comp in the third quarter as we benefit from Sephora across shoppers and investments we've made into our proprietary assortment. Moving forward, we're continuing to look for ways to optimize our store layout to enable us to capture incremental sales. In addition to the store layout, we are enhancing the shopping experience by increasing the inspiration in our stores. A few ways we are achieving this are by showcasing newness and relevant styles with mannequins and enhancing brand awareness and findability through in-store graphics. You will start seeing some of this in-store inspiration in Q4 with our holiday displays with most of the inspiration to set in 2026. Digitally, we continue to make solid progress applying artificial intelligence to improve efficiency and elevate the customer experience. AI is helping our engineers work faster to complete site updates and enhance our app performance. In marketing, predictive AI is guiding media investments and personalizing offers and generative tools are helping creative teams produce content faster. While many initiatives are still developing, we are already seeing benefits in productivity, agility and customer engagement. We're taking a disciplined approach to scaling these capabilities as we continue to modernize the business and position Kohl's for long-term growth. Lastly, we remain extremely focused on restoring trip assurance to our customer experience. This is a core pillar of what Kohl's is known for, and our increased choice counts over recent years has resulted in limited debt in key essential items. We're making progress in this, specifically in our women's business with categories like intimates and dresses, both of which made edits to exit out of less productive styles. We're also investing into depth for key sizes, helping deliver improved sales performance in both categories. As we continue to prioritize this initiative, we're using AI to help optimize our inventory allocation which will help provide a more consistent and reliable shopping experience going forward. Now I would like to give a preview on how we're approaching the ever-important holiday season. We're excited about the momentum and opportunity we have heading into the holidays. The holidays are always a promotional time period, and we expect this to continue this year, especially given the state of the consumer. We have done a lot of great work throughout the year to show up for customers as a destination for exceptional value and gifting, a 1/3 of which will be exclusive to Kohl's. We entered the quarter in a better inventory position particularly with our proprietary brands, which will be essential in offering value to our customers in holiday through our sweaters, knits and fleece offerings. In Sephora, we expanded our holiday gifting steps which have continued to resonate well with our customers. We're also building on new brand launches from Q3 with additional brands like Danessa Myricks, Astora, Biodance and Kayali, which has become our #1 fragrance in women's. In addition to proprietary brands in Sephora, we're excited about the product offerings in our home category this year. In hard home business, we're thrilled to offer new items such as the Green pan by body flay alongside new innovative items from key brands like Ninja and Shark. On the soft home side, we're emphasizing our bedding with value-oriented brands like Cuddl Duds and Cozy throws from Big One. Importantly, toys will be a key gifting category for us this holiday. We're excited about our offering of trending toys like Barbie, LEGO and Tonies 2, as well as toys from favorite brands like Hot Wheels and Step2. This year, we're also seeing great engagement with our trading card offerings like Pokemon. From a marketing standpoint, we're making a statement in front of the store that is designed to inspire featuring everything customers need to welcome the holidays, find thoughtful gifts for the family and host and style. We're leading with compelling value to our customers, leaning into Kohl's cash and awards, which helps drive repeat trips and increased engagement. Additionally, given the changes we made to our coupon inclusion this year, our customers will have more purchasing power this year compared to last year. Before I turn the call over, I want to reiterate the key messages from this call. First, our improved performance in the third quarter is a direct reflection of momentum we're building to better serve all customers. Second, we're making great progress against our 2025 initiatives. We're encouraged with the results, but still have more work to do. And third, we're excited about how we are positioned to deliver exceptional value to our customers during this important 2025 holiday season. All this progress and momentum could not have been made without the incredible work from our Kohl's associates. We have made great strides together as a team, and each day, I work with you, I am more and more impressed with our resilience and desire to win. The opportunity that lies ahead of us is clear and substantial, and we are committed to making more progress each quarter. With that, I would now like to hand the call over to Jill. Jill Timm: Thank you, Michael. For today's call, I'll provide additional details on our third quarter results and give an update on our fiscal year 2025 guidance. Net sales declined 2.8% in the quarter and 4% year-to-date. Comparable sales declined 1.7% in Q3 and declined 3.2% year-to-date. The third quarter improvement was mainly driven by an increase in transactions versus prior quarter, while our average transaction value remained flat year-over-year. In addition, proprietary brands ran a positive comp in the quarter with business accelerating as the quarter progressed. Digital sales outperformed stores again in Q3 and grew by 2.4% versus last year. This performance was driven by an increase in traffic throughout the quarter going from high single digits in August to high teens in October. From a customer perspective, we saw significant improvement in our Kohl's card customers, which were down high single digits in Q3, an increase in trend of over 500 basis points in the last quarter with the improvement coming from both the store and digital channels. Moving down the P&L. Other revenue, which primarily consists of our credit business, was $168 million in Q3, a 17% decline compared to last year. As a reminder, we launched our co-brand credit card last September, so on a comparable basis, starting this quarter, we are no longer receiving the incremental benefit seen in the first half of this year. In addition to this, we continue to face a headwind as we shifted some credit-related expenses from SG&A into other revenue. While our Kohl's Card still remains pressured, we made meaningful progress reengaging this customer throughout the year. We remain committed to furthering this progress as we continue into Q4 and next year. Gross margin in Q3 was 39.6%, an improvement of 51 basis points versus last year. This year-over-year improvement was driven primarily by strong inventory management and product mix benefits driven by our positive proprietary sales performance this quarter. Year-to-date, gross margin was 39.8%, an increase of 39 basis points to last year. SG&A expenses declined 2.1% to $1.3 billion in Q3, driven by lower spending in stores, marketing and fulfillment with additional savings stemming from a portion of credit expenses shifting into other revenue. Year-to-date, SG&A expenses have declined 3.8%. Depreciation was $176 million in Q3, a decrease of $8 million versus last year. The decrease was driven by lower capital expenditures and the impact from closed locations. Year-to-date depreciation expense $526 million, down $34 million for the prior year. Interest expense was $75 million in the third quarter and $229 million year-to-date. In the third quarter, we realized a benefit of $9 million within our adjusted tax line. This benefit was due to the release of tax reserves. We now expect our full year tax rate to be roughly 18%. Adjusted net income in the third quarter was $11 million, equating to an adjusted diluted earnings per share of $0.10. Year-to-date, adjusted net income of $61 million and adjusted diluted earnings per share is $0.54. Moving on to the balance sheet and cash flow. We ended Q3 with $144 million of cash and cash equivalents. Inventory decreased approximately 5% compared to last year in Q3. We are positioned well from an inventory perspective as we head into the holiday season as we had a better flow of inventory this year and brought in inventory earlier than last year, which had elevated in-transit levels. Year-to-date, our operating cash flow was $630 million, and our adjusted free cash flow is $270 million. We remain on track to achieve $1.3 billion of operating cash flow and $900 million of free cash flow at the end of this fiscal year. Our borrowings on the revolver declined to $45 million at the end of Q3, over a $700 million decrease from last year. We remain committed to fully exiting the revolver by the end of this year. Capital expenditures ended at $308 million year-to-date. We are on track to spend approximately $400 million of CapEx this year, with the majority of these investments relating to the completion of our full chain Sephora rollout, implementing 613 additional Impulse Q lines, and the expansion of one of our next-generation e-commerce fulfillment centers. Year-to-date, we have returned $42 million to shareholders through our dividend. And as previously disclosed, the Board on November 12, declared a quarterly cash dividend of $0.125 per share payable to shareholders on December 24. Next, I would like to provide an update to our 2025 outlook. As mentioned previously in this call, we made meaningful progress to date on our 2025 initiatives. Each quarter, we have made sequential improvements in our key areas of focus, including investments into our proprietary brands and debt accounts delivering competitive value through our promotional strategy and optimizing our store layouts, all of which are continuing to resonate with our customers. With that said, we continue to navigate a fluid and dynamic macroeconomic environment. We recognize that our middle to low-income customers are experiencing persistent pressure and a tightening of their discretionary income. We aim to be mindful of this as we lay out our updated outlook. For the full year, we expect net sales decline of 3.5% to 4%, comparable sales decline of 2.5% to 3%. Other revenue down 11% to 12%, gross margin expansion of 30 to 35 basis points, and SG&A decline of 3.75% to 4% and adjusted diluted earnings per share of $1.25 to $1.45. Lastly, I would like to emphasize my sincere appreciation of the incredible team here at Kohl's. We have been able to make significant progress on our goals despite navigating an uncertain and challenging environment, thanks to your continued commitment. I'm excited to continue this progress forward with all of you. I want to reiterate the importance of your impact to both our customers and our organization. We are now happy to take your questions at this time. Operator: [Operator Instructions] Our first question comes from Chuck Grom from Gordon Haskett. Charles Grom: And first of all, congrats, Michael on the new responsibilities. At a high level, I'm just curious, as you guys add back brands to the coupon eligibility list and make changes to the store layout and bring more of the prop brands back, how you're connecting with former and lapsed customers to make them aware of the changes? And where do you think you are, I guess, on that recovery path at this point in time? Jill Timm: I think, Chuck, we have -- the good news is with our core customers, they were still shopping us, we just lost some of their trips. So we have a lot of data around that customer. We know what they like to shop with. We know when they shop. So our marketing team has been able to use a lot of that data to go after them from a marketing perspective. I would say that's been ramping up because as we've been bringing back in the items into the coupon, as we've been bringing the proprietary inventory back into our stores. We want to make sure when we did invite them in, that we were in stock and the items that they were looking for. Similarly with the jewelry brand and Petites coming in because they actually over penetrated into the brand -- those brands as well. So this past quarter, we did some personalization in terms of coupons. We know that resonates really well with them and actually made it in Kohl's cash as well. So we took away the exclusion headwind from that perspective as well. And we've really seen high engagement from that. So we're pleased with the trend improvement we've seen in the Kohl's charge customers up 500 basis points in the quarter. But clearly, we still have room to continue to move forward. And I think as we bring back in those brands, we continue to market to them, we're going to get more of their footsteps, particularly during this key holiday period. Michael Bender: And Chuck, I would -- just to add that the difference that we see between both the brick-and-mortar and the digital side of that question that you're asking, we see a more immediate response on the digital side. Obviously, when we're able to communicate the brands that are back in the coupon. From a store perspective, we're still building that and we're doing things like making sure that when there's an item in a store that is coupon eligible that we're placing a sign, for example, on the fixture that says this item now coupon eligible, that will -- that ramp-up will take a little bit more time than what you see from a digital perspective. But we're excited, as Jill said, about the progress that we're making there and unifying those efforts. Operator: Our next question comes from Paul Lejuez from Citigroup. Paul Lejuez: Joe, can you maybe break down that $1.3 billion of operating cash flow. Just talk about the net income versus the onetime items versus working capital benefit within that? And then maybe if you can talk about CapEx, I think you said $400 million this year. How should we think about a CapEx number over the next several years? And then I just wanted to make sure I understood the traffic versus ticket in terms of the drivers of the comp this quarter. I think maybe you said what happened versus last quarter. I'm just curious on an absolute basis year-over-year. What the drivers of comps between traffic and ticket. Jill Timm: Sure. So I think, first, obviously, $1.3 billion in operating cash flow, we feel really good with the momentum that we've made there in addition to paying off over $700 million on the revolver. So we'll clearly have an exit plan for that by the end of the year. I mean, a big portion of what you're seeing, we did have the onetime gain, as you alluded to, which is about $100 million that we recognized last quarter, but the majority of this cash flow is coming through our strong inventory management. And I think that's the big thing. Inventory down 5%, on the quarter where we were down 1.7% from a comp perspective. We continue to expect to manage our inventory down in that low to mid-single-digit number. So I think that's really where we're seeing. We had a better flow of goods coming into Q3 this year, which we do believe helps accelerate our business as the quarter progressed, and we continue to flow those goods I think more timely has been helpful to us, but it's also been beneficial from a cash flow perspective. So I think I would really narrow it down to inventory management being a key unlock and we expect that to continue. We have opportunities to turn faster as an organization. We've had this conversation and the faster return, the more we can generate from a cash flow perspective. So I feel very confident that this is a level of cash ex the onetime that we can continue to operate at. From a CapEx perspective, at $400 million, obviously, we completed the Sephora rollout. We accelerated the Impulse lines given the fact that they were working so well in the front half of the year, we really leaned into them and to get them in almost all stores by the back half of the year. It's really an extra unit in the basket outsized impact in the stores. As we go into next year, I'd suggest that our level will probably be in that $350 million to $400 million range. Obviously, we'll ebb and flow based on any big products. And if we have a big new project to lay out, we would obviously call that out separately, but I think that's a good run rate to use as we move forward. And I think the third question from a traffic and ticket perspective, our average transaction value is relatively flat. So the difference for the quarter from a comp perspective is really about traffic, but also the improvement from last quarter and that down 4% to the down 1.7% was all about improved traffic. And the improvement we saw throughout the quarter with October actually getting to a positive comp with all driven by improvement in traffic. So those trends have continued to improve, helping drive the momentum that we've discussed. Operator: Our next question comes from Mark Altschwager from Baird. Mark Altschwager: Congratulations, Michael. Michael, which of the strategic initiatives outlined at the start of the year are showing the most promise? And how are you evolving the strategy to stabilize comps based on the learnings year-to-date? Michael Bender: Yes, thanks for the question. Of the three initiatives that we started out with, I would say that one of the ones that I'm most proud of in terms of the progress that we're making is around this notion of building a more balanced assortment. We've focused a lot of attention over the last, call it, 6 to 9 months on making sure that what we're offering to customers, particularly from a value perspective is what they're looking for. And Kohl's has historically been known for being able to offer choice, but also depth so that there's Trip Assurance. That's the piece that we underscore quite a bit about making sure that that's what we're known for. So if you take categories like in women's dresses intimates, there's been an awful lot of work done in those two categories in particular to reset and edit some of the choices that we've had and make sure that the depth is available for our customers. So there's still work to be done in that instance. But we feel really good about that work. I would say secondly, the -- in general, the focus on proprietary brands and making sure that we're bringing those forward and achieving -- I'll say, what is the proper mix. And again, we don't have a target, but we have a customer-led mindset about where we need to be with proprietary brands. The curation of that assortment has been a big positive for the business, as Jill noted, in terms of the progress that we're making and the performance that we're seeing from our efforts there. And it dovetails nicely into being able to support opening price points for customers who are pressured these days. And so it marries nicely with where the customer mindset is right now. Those are a couple of areas that I would focus on. Mark Altschwager: That's great. And so do you think you have the pieces in place to deliver top line growth as we look into 2026? And then separately as a follow-up for Jill. How should we think about the further opportunity for cost savings on the SG&A line and the ability to sustain SG&A dollars down year-over-year over the next several quarters? Michael Bender: Mark, I would say on your question about our trajectory toward growth. Clearly, that's what we talk about on a daily basis here internally. I think the performance that we've shown consecutively now over the last three quarters of the progression toward growth is an indicator like that, the kinds of things that we're focused on delivering on behalf of the customers is what we should be working on. I don't like to put a timetable on it and say, on April 21, that's when you'll see growth. But we've shown in October, I think, is a good example of -- we have the ability to get to a positive growth trajectory in the business. And that's what we're doing every day in the work that we're advancing here. Jill Timm: And then from a cost perspective, I think we have a history, I think, of managing our business with good cost discipline. Obviously, our cost being down 2% in the quarter on the down 1.7% comp. So we continue to find ways to be much more efficient. I think this is just instilled in our organization, and it is something that we are constantly looking for is how can we do things more efficiently more productively, how can we leverage technology in what we're doing, day in and day out. We've introduced a lot of new technology, whether it be within our new e-fulfillment centers within our stores to help us have those efficiencies. So I feel like the model and the discipline that has been established within the organization will help us continue to sustain that cost discipline. I think the variable model we run runs really well. So if we get to positive growth, we should be adding those expenses in to support that as well. So I think that's the model. As you know, we think we can leverage typically around that 1% comp. We've done better than that this year as we've really known we needed to tighten so we could open up funds to help us continue to drive into the initiatives that we've outlined to really help drive the progressive improvement you see on the top line. Michael Bender: And Mark, I would just say in answering your earlier question a little bit further to around what's going to help us get to a positive growth trajectory. We spend a lot of time inside the business since I've been on board, focusing on product. And making sure that that's at the center of how we actually drive the business. We do well with promotions. We have that down. But -- to the extent that there is a focus on product and making sure that we are both relevant, styles are right, and it speaks to the customer in a compelling way, that's where we've been spending a lot of time making sure that we're focusing our efforts in that regard. And that is one of the things -- one of the big things that's helping us show some of the results that we're speaking about today. Operator: Our next question comes from Bob Drbul from BTIG. Robert Drbul: Michael, congratulations. On the -- Jill, a question for you. On the gross margin side, when you think about sort of the fourth quarter and I think just when you generally look at some of the adjustments and changes that you're making to the promotional cadence and exclusions, can you just talk us through like the bigger drivers of your outlook and how you think about the opportunities with private brands, et cetera, contributed? Jill Timm: Sure. I think, obviously, first, if I start with where we were in Q3, up 50 basis points we really benefited one, from the inventory management I spoke to, by flowing goods more current and trend right, we're able to have a better reg selling price. That will continue as we move into Q4. Also, we benefited from mix in a couple of different ways. One, our proprietary brand portfolio running a positive comp in that side of the business, obviously, has an outsized impact to our margins to the good side. Second, if you underlook the categories from a home perspective, we knew electrics would underperform. We knew that there was going to be some pressure there and brought that down based on our elasticity analysis of where prices were moving. But we overperformed in our soft home, which has a better margin structure for us. So overall, we start seeing mix really benefiting us. I think those things will continue to persist as we get into Q4. A couple of the headwinds, which is why we guided that margin a little softer than you saw in Q3. One is digital becomes a bigger portion of our business in Q4. So we will have added pressure from a cost of shipping perspective. And then we also expect it is a highly promotional time. We know that we have a low and middle income customer that are going to be more choiceful and they're really seeking value. So we wanted to be set up so we could have that ability to really lean into value and our promotions during that time of year to ensure that we are meeting the customer where they needed to be met and also grabbing those sales from that customer, particularly that core credit customer, who loves the deal. Robert Drbul: Great. And I just had a question on the -- I guess, on the debt and with the progress you made on the revolver. Can you just talk us through sort of rebuilding the cash balances like how you think about your debt position at this point? And any sort of targets as you think about heading into '26? Jill Timm: Yes. First, if I look at just the debt outstanding, I think we're about $1.5 billion of debt outstanding. So I actually look at our net debt leverage at about 1.2x. Obviously, our leases, which, as you know, we had to reset a lot of our leases when we put in the Sephora shops in all of our stores. So when you add in the leases, that's what really brings our leverage ratio up. And if I break that into two pieces, we're really signed in for our first term of an extended lease payment, which averages about 4 years. So if you add that back in, it brings our lease leverage ratio to about 2.6x, but then when you add in the extended term, which is what we're using on our balance sheet because that's what we're depreciating our asset over is what brings you to the 4.5x leverage. So I actually feel very good with $1.5 billion outstanding. We just refi-ed our long-term debt. We have nothing coming -- we don't have a stack coming due for 5 years. And as you saw, we deleveraged our balance sheet by about $700 million from last year. We'll be completely out of the revolver by the end of this year, which gives us additional liquidity of $1.5 billion as well. So I feel very well positioned from a balance sheet perspective. And then as we talked about, generating $1.3 billion of operating cash flow, really benefiting from that inventory management, which we think will be a continued benefit for us into 2026 as well. Operator: Our next question comes from Oliver Chen from TD Cowen. Oliver Chen: Hi, Michael and Jill. On the progress you've made how might you rank order some of the progress in terms of the opportunities on that positive comp opportunity with categories and/or strategies. Also was credit card income in line with what you expected and anything we should know in terms of making sure we model that correctly going forward? And then on the topic of speed in the organization, what's ahead for driving that? I know it's critical for merchandising and there's lots of AI opportunities and the demand volatility has been unprecedented. Kohl's Cash is also iconic. And I know that program has been an opportunity to simplify. But any updates there as well. Michael Bender: Great. So that's four questions in there. We'll try to address those, Oliver. The first one, in terms of rank order of the growth in the initiatives work, I would say that again, the focus that we've had on getting the assortment right, I rank as probably at the top of the list. Inclusive in that, as I had mentioned, around proprietary brands and getting the mix between national and proprietary brands in a better place. I feel like we've made some really good progress on that front. Reassorting ourselves in terms of the style and relevancy of the product and the focus that we have there, I spent a lot of time myself with the teams, particularly on the women's side of the business since I've been on Board because as you know, women's here at Kohl's drives Kohl's. So -- that's been the focus for me in the first, call it, a couple of months or so of really digging in with the merchant organization. I would say also that what you should see going forward from us and what I'm excited about also, you saw that we hired in the last three months or so, the new CTO, Steve Dee, as well as new Chief Digital Officer, Arianne Parisi, and building out an experience that's truly omnichannel and to your point, modernizing the business. They have leaned in very quickly both of them on helping us think through from a more commercial standpoint, what needs to happen in the business from that perspective. So those are a couple of areas that I would highlight in answering that first question that you have on. Jill, you want to take credit and... Jill Timm: Sure. From a credit perspective, it didn't come in where we expect it to be. Obviously, we guided it down as we lapped the launch of the co-brand last year. You can see in the implied guide that it will get slightly better in Q4. What I would say is our Kohl's Card customer sales did improve that 500 basis points. But as you know, it just takes a little bit of a lag for that AR to build and then revolve. So it's always going to be lagged based off performance before it hits into that credit line. The other thing I would call is our payment rates do remain above last year. So that comes back into not building as much from an AR perspective and also a little bit less late fee income. And then although our loss rates are elevated, we actually did see them down slightly in Q3. So I feel pretty good with the health of the portfolio. It's really just continuing to get that credit card customer coming in, shopping and letting their balances revolve to bring that back in. So we are expecting a little bit of the benefit into Q4, and then you should see more of that benefit as we enter into 2026, just given the lag of how that credit line runs. I think from a Kohl's Cash perspective, I mean, you nailed it. It is iconic. We did actually celebrate our Kohl's Cash anniversary and put a whole event around it during this quarter, which was great. I think, hopefully, you saw that Oliver out on our social media because it was well attended by many as we are giving out some Kohl's Cash gifts and people really love what that looks like. As we move into the holidays, we'll continue to leverage this as well. We have events planned around it. It's a way for us to get around. Obviously, it could be used in everything. So there is no exclusions. You earn it, you can come back and redeem it. People love to earn it on gifts that they're giving and use it on a self-gift during the holiday period. So I think this is definitely something that has set Kohl's apart and really resonates with both our Kohl's Charge and non-Kohl's Charge customer. And so our marketing team has done a really great job of exploiting that. Oliver Chen: Okay. I had a follow-up, Michael, the company has been on this journey with merchandising in the past and differentiation has been important in making sure the brands don't all seem the same or trend right. I guess what's different this time? Or what are your plans in terms of what's going to be distinguished? And that should be a really easy compare. What should we know about the compare versus momentum, but it's a compare nonetheless? Sephora being negative, was that -- I know that business is remarkable, but was it a surprise that it was negative? BD has been overall pretty vibrant. Michael Bender: Yes, I'll take the Sephora question. Jill, please chime in too if there's more to say about it. But the Sephora business is something that we're really excited about. As I've mentioned in the past, it's approaching a $2 billion business for us over a 4-year time period, and we feel good about the progress that we're making there. We've mentioned in the past that with this being now a 4-year-old business, you see similar to how a store matures that business looking that way in some cases. But Sephora also, as we've mentioned, has an incredible pipeline of opportunity to bring newness and innovation. We mentioned MAC coming in spring of next year. Those are the kinds of things that will continue to fuel the growth of that business, and we feel very good about where Sephora sits. I have no concerns at all about that at all. Jill Timm: And I think in terms of where you're talking about updates from a branding perspective, I think the big thing, and Michael called this out a couple of times is we're really listening to the customer. So moving back into proprietary brands, we are a void of an opening price point, Oliver, in our store, and our customer came to look for value. They came to look for the brands that they had known at Kohl's and they couldn't find that on the floor. So we're making that investment back into our proprietary brands, but we're doing it in a really thoughtful manner. We're not over-correcting. Our inventory last year in Q3 and proprietary brands was down about 30%. This year, we're up about 11%. So still on a 2-year stack basis, we're down, but we're making those moves and making the right investments. And we're doing that in a better timely manner than what we have seen in the past. We are also editing out some of the redundancy we're seeing on the floor so that these brands can stand out more. We've made reductions so that we can have from a dress perspective, we can have a really great dress assortment, but we're going to do on half the racks that you've seen in the past because that's really what the customer was shopping and we saw our most productivity out of it. We're starting to make some of those adjacency analysis and making those moves within our store. We've talked a lot about accessories and juniors. We know there's more to come from that as well. So how can we take advantage of what we know the customer is putting in their basket and what could be that next item that they're looking to purchase for as well. I think the big thing is trip assurance that we've talked about, and that's probably in the more early innings of things, we are starting to see, particularly as we move into Q4, that you're going to see our receipts are going to be more about adding depth on the floor and less choice count and really being able to drive back that trip assurance our customer had come to known us for that we really disappointed her with. So I feel like the progress we've made is we got back into the coupon that's really resonated with our Kohl's Card customer. We moved into the proprietary brands and jewelry and petites, all of which have outperformed and our customers voted yes on. And now we're going to start making some of those changes with our floor pads as well as investing more into depth, especially as we move into 2026. You're also going to see as we move into '26, a better way of transitioning our goods. So we're going to see a much more transitional time in January and into February, given the even strong inventory management we had, it's allowing us to have those moments and flow goods more timely so we can take advantage of that first mover opportunity that we probably missed out on in the last couple of years. Operator: Our next question comes from Dana Telsey from Telsey Group. Dana Telsey: Congratulations, Michael, and nice to see the progress. Obviously, a lot of talk about proprietary brands in the progress and enhancements being made there. Certainly seems like women's is the core. Any other brands you would call out or categories that you would call out on proprietary to watch for that can be meaningful. And what does it mean at all if anything changes on the tariff side. Jill, what does that mean to margins? How are you thinking about it? And then just brand inclusion in coupons, are you done with that? Where are you on the coupon cycle with brands? Michael Bender: I'll start with that first question, Dana. In terms of the bucket of coupon inclusions, I think for now where we want to be, we've done two tranches, a big one back in April and the latest one in August, and we feel good about the progress that we're making there and what we're seeing from customers, particularly as it relates to the Kohl's credit card customer. Mouthful. And that's one of the things that we're excited about in terms of what we're seeing there. As far as other brands or categories that we see, for me, there are several, but one that I'll highlight would be in the active side, both tech and Flex are areas that are important for us. We mentioned earlier in the comments about the fact that we feel so good about Flex that we've extended into kids in 300 stores. There'll be 300 more in the spring and then a full almost every store by June of next year is where we're headed with that. So those are -- that's an example of the kinds of things that we're focused on in terms of additional focus on proprietary brands and extending it outside of the categories that we currently have. Jill Timm: And then your question on tariffs, Dana, I think, obviously, this quarter, we did well. I think it had less of an impact. So I really want to give a shout out to our merchant and sourcing teams. They've done an incredible job navigating this dynamic environment and letting it really add up in a great place in terms of how we showed our margins. We do expect that this will be a little bit more pressured as we go into Q4 and into 2026 first because we'll have a full year of this exposure. And also, I think just there's more certainty around what these tariffs mean. So we're going to have a little bit more pressure as we do move into '26, but we feel good with our ability and how we've offset them to date. I just think with the certainty, we're going to see a lot more movement there as we go into 2026, both with our proprietary brands and our national vendors. Dana Telsey: Got it. And just one last thing, if it hadn't been mentioned. Anything on the store portfolio, how you think about openings, closings, relocations going forward? Michael Bender: Yes. I would just say that that's a normal hygiene practice for us to review our store fleet. The good news is that the vast majority of our stores, well over 90% are profitable and productive for us. And so as we do at the beginning of every year, we'll take a look at our stores. And if we deem there to be any necessary adjustments, we'll make that. But as we did last year in closing 20 or so stores, we'll take a look, but that process is underway. Yes. Operator: We are of time for questions today. This will conclude today's conference call. Thank you for your participation. You may now disconnect.
Operator: Good day, and thank you for standing by. Welcome to the Zscaler First Quarter 2026 Earnings Call. At this time, all participants are in a listen-only mode. Please be advised that today's conference is being recorded. After the speakers' presentation, there will be a question and answer session. To ask a question, please press 11 on your telephone and wait for your name to be announced. To withdraw your question, please press 11 again. I would now like to hand the conference over to your speaker today, Ashwin Kesireddy, VP IR and Strategic Finance. Good afternoon, everyone. And welcome to the Zscaler First Quarter Fiscal Year 2026 Earnings Conference Call. Ashwin Kesireddy: Good afternoon, everyone. And welcome to the Zscaler First Quarter Fiscal Year 2026 Earnings Conference Call. On the call with me today are Jay Chaudhry, Chairman and CEO, and Kevin Rubin, CFO. Please note, we have posted our earnings release and a supplemental financial schedule to our investor relations website. Unless otherwise noted, all numbers we talk about today will be on an adjusted non-GAAP basis. You will find the reconciliation of GAAP to the non-GAAP financial measures in our earnings release. I'd like to remind you that today's discussion will contain forward-looking statements, including, but not limited to, the company's anticipated future revenue, annual recurring revenue, calculated billings, operating performance, gross margin, operating expenses, operating income, net income, free cash flow, dollar-based net retention rate, future hiring decisions, remaining performance obligations, income taxes, earnings per share, our objectives and outlook, our customer response to our products, and our market share and market opportunity. These statements and other comments are not guarantees of future performance but rather are subject to risk and uncertainty, some of which are beyond our control. These forward-looking statements apply as of today, and you should not rely on them as representing our views in the future. We undertake no obligation to update these statements after this call. For a more complete discussion of the risks and uncertainties, please see our filings with the SEC, as well as in today's earnings release. I also want to inform you that we'll be attending the following conferences: UBS Global Technology and AI Conference on December 3, Barclays Tech Conference on December 11, and Needham Growth Conference on January 14. Before I turn the call over to Jay, I wanted to share that I recently transitioned to a new role as product manager of AI security at Zscaler. So this will be my last earnings call as the IR leader. It's been a pleasure engaging with all of our shareholders over the last few years. Kim Watkins, who some of you may know from her tenure at Intuit, will be joining Zscaler in early December to lead investor relations and strategic finance. Please join me in welcoming Kim to Zscaler. Now I'll turn the call over to Jay. Jay Chaudhry: Thank you, Ashwin. We had a strong start to our fiscal year. In Q1, annual recurring revenue or ARR growth accelerated to 26% year over year, and RPO growth accelerated to 35%. Combining our strong free cash flow margin of 52%, and revenue growth of 26%, we operated at rule of 78, making us one of the rare companies consistently outperforming the coveted rule of four d metric. We are one of the only five enterprise SaaS companies with over $3 billion in ARR, growing at over 25%. The continued success of our three growth pillars—AI security, zero trust everywhere, and data security everywhere—is driving our strong top-line performance. ARR from these three growth pillars accelerated in the quarter. I'm particularly pleased with our AI security pillar, which grew over 80% year over year and has already exceeded our FY '26 target of $400 million ARR, three quarters earlier than expected. With the strong demand, I expect AI security ARR to exceed half $1 billion by the end of this fiscal year. Diving deeper into our AI security pillar, while enterprises are leveraging AI to drive innovation and accelerate productivity, the proliferation of AI is also making them increasingly susceptible to attacks. One of the largest AI companies recently reported that a bad actor hijacked its AI coding assistant to autonomously perform a large-scale cyber attack against multiple organizations. This incident highlights two important trends. First, threat actors are using AI to dramatically increase the speed, effectiveness, and blast radius of attacks. We have been predicting an increase in this type of automation by AI agents, and we are now seeing it happen. Second, just like users and organizations, AI agents are also becoming the weakest link in their security. It is only a matter of time before millions of AI agents interact with each other across enterprises. Imagine a threat actor hijacking even one of an organization's trusted agents, and thereby accessing critical corporate resources and sensitive information resulting in a serious breach. We have a long history of securing users with our Zero Trust Exchange, which enabled our customers to safely adopt the latest technologies such as mobile, cloud, and SaaS. Over 45% of Fortune 500 companies and nearly 40% of global 2,000 companies have adopted our Zero Trust Exchange and trust Zscaler to secure their businesses. With the rise of consumer GenAI applications, including ChatGPT, Perplexity, and more, security issues related to access control, data loss, and content moderation made enterprises cautious about allowing employees access to these popular apps. We extended our Zero Trust Exchange to provide visibility into thousands of GenAI apps, enabling enterprises to inspect prompts and responses and enforce proper guardrails for safe and secure use of GenAI apps. Several large enterprises adopted our GenAI solution in the quarter, including a G2K technology company, a Fortune 500 communications equipment company, and a large healthcare software provider. As AI adoption moved beyond consumer GenAI apps into building and running enterprise AI applications, we introduced solutions in three key categories to secure that. First, AI asset discovery and posture management. AI applications and agents are being developed and deployed today without full visibility for IT teams to safeguard them. To provide organizations with visibility and control, last year, we introduced an AI asset discovery solution called AISPN. AISPM can detect unauthorized AI applications, prevent over-permissions for AI agents, and strengthen governance for model deployments. In Q1, several customers, including a leading software solution provider, a global 2,000 manufacturer, and a leading insurance company, purchased AISPM from Zscaler. With our recent acquisition of SPLX, we are extending our AI SPM capabilities by unifying discovery of LLMs, workflows, and MCP servers. These capabilities enable customers to meet evolving regulatory requirements for AI to be transparent and explainable, among others. The second key area of innovation is AI red teaming. As part of the AI lifecycle, customers need to regularly test their applications for vulnerabilities. With SPLX, we now deliver AI red teaming to enable automated and continuous testing of AI apps at scale. Our AI red teaming solution integrates with customers' CICD pipelines, making it easy to test for hallucination, bias, behavior drift, and more. Several customers, including a Fortune 150 transportation company and a Fortune 100 service provider, have already deployed AI Red Team. The third area of innovation is AI guardrails. Customers need AI guardrails for inline policy enforcement for acceptable use of AI, for cybersecurity, and for data loss prevention. Inline policy enforcement is one of our key differentiators, which we seamlessly deliver through our Zero Trust Exchange at scale. As we process half a trillion transactions daily, our AI Guard solution leverages the core competency for runtime protection. Zscaler AI Guard sits between the application and LLMs, inspecting prompts and responses inline to enforce customer-defined policies. To share an example, this quarter, a leading consulting firm purchased our AI Guard to secure the use of public AI applications and their private in-house applications such as AI chatbots and AI agents. With our platform capabilities, we are securing over 90 billion AIML transactions per month. As AI and AI agents define the next era of transformation, we are further extending our platform to secure AI agents, agentic workflows, and AI applications. In addition to securing the use of AI, we are leveraging AI to deliver agentic operations, including agentic SecOps and AgenTeq ITOps. In our AgenTic SecOps, we are making great progress towards delivering an AI-powered SOC that simplifies customers' operations and hunts for threats. In August, we acquired Red Canary to combine the agentic technology with our data fabric technology to deliver actionable SOC insights for our customers. This quarter, a Fortune 500 financial services company, a global 2,000 healthcare equipment company, and a global 2,000 energy company, and more purchased our AgenTek SecOps solution. In our agentic IT ops, we are introducing several Zscaler Digital Experience or ZDX innovations to enable faster resolution to application and network performance issues. Other innovations like the ZDX CoPilot continue to resonate with customers and have driven over 80% year-over-year growth in bookings of ZDX Advanced Plus in the last twelve months. I'm very pleased to see continued momentum for our AI security solutions. As I mentioned, we are expecting AI security ARR to surpass half $1 billion by the '26. Turning to our second growth pillar, we continue to see strong momentum in Zero Trust Everywhere, which includes Zero Trust users, Zero Trust branch, and Zero Trust cloud. Three quarters ago, we introduced Zero Trust Everywhere and set a goal to secure 390 enterprises with Zero Trust Everywhere by the '26. I'm delighted to share that we now have over 450 Zero Trust Everywhere enterprises, achieving our goals three quarters ahead of our target date. Our Zero Trust Everywhere customers benefit from reduced cost and complexity by eliminating legacy network and security products. This expanded relationship through Zero Trust Everywhere also creates follow-on demand for data security and AI security. One of the key components of Zero Trust Everywhere is Zero Trust Cloud, which allows customers to eliminate VPNs, north-south and east-west virtual firewalls, ExpressRoute, and Direct Connect networks, resulting in far better cybersecurity. To share a customer example, in an 8-figure TCV win, an existing million-dollar-plus Fortune 500 healthcare customer adopted our Zero Trust Cloud solution, along with ZDX Advanced Plus, data security modules, and more. Zero Trust Cloud secures workload communication across the VPC or virtual private cloud and SAP RISE cloud-based ERP. Without Zero Trust Cloud, the customer would have had to deploy a significant number of north-south and east-west firewalls, resulting in increased cost and many months of delay. This customer told me that in the last fifteen years, they have not been so excited about the solution that not only brought better security but also was easy to deploy and operate. Just like the migration of Microsoft Exchange to Office 365 was a big tailwind to our business a few years ago, I believe the migration of SAP on-prem to SAP Rise will have a similar impact on our business. We continue to see strong interest from customers for Zero Trust Branch, which is another key component of Zero Trust Everywhere. Zero Trust Branch eliminates the need for legacy point solutions at branches, factories, and campuses. To give you an example, in a 7-figure upsell win, a global 2,000 manufacturing customer more than tripled their ARR and became a Zero Trust Everywhere customer by purchasing our Zero Trust Branch, ZDX Advanced Plus, Risk 360, and more. Moving to Data Security Everywhere, we offer a comprehensive data security portfolio with eight modules providing data discovery, data classification, posture management, data loss prevention, and more. Customers are eliminating data security point products in their environment by consolidating data security functionality on our unified platform. To share an example, in a seven-figure new logo ACV win, a large healthcare provider purchased five out of our eight data security modules for their 23,000 users. This enterprise chose Zscaler over a leading CASB vendor due to our integrated platform, which delivers data security across all channels for all types of data. I'm excited to share that our Data Security Everywhere ARR accelerated to approximately $450 million. The growth across our three pillars is powered by our strong go-to-market engine. One of the key initiatives we recently introduced was our Z Flex program, which enables customers to commit to a spend and provide flexibility to swap or activate additional modules without undergoing new procurement cycles. Z Flex is driving meaningful upsells and reduced sales cycle and is consistently exceeding my expectations. Z Flex generated over $175 million in TCV, growing over 70% quarter over quarter. To share a couple of customer examples, an existing large aerospace customer made a multiyear 8-figure TCV commitment under the Z Flex program, increasing the annual spend with us by over 40%. As part of the Flex commitment, the customer added nine new modules, including asset exposure management, identity threat detection, unified vulnerability management, email DLP, and expanded commitment for data security. In a 7-figure upsell win, a Fortune 500 business services provider more than doubled the annual spend with us as they expanded adoption of nine modules under the Z Flex program. In conclusion, our business is benefiting from the strong tailwinds from the combination of zero trust and AI security. The best AI security is built on the foundation of Zero Trust. Our clear leadership in zero trust security combined with our comprehensive AI security offerings positions us well to capture the large and growing AI security market. And with our strong go-to-market engine, we are well positioned to exceed $10 billion in ARR. I would like to turn over the call to Kevin for our financial results. Kevin Rubin: Thank you, Jay, and good afternoon, everyone. We exceeded our growth targets in Q1 and operated at rule of 78 for the quarter. We ended Q1 with over $3.2 billion in ARR, reflecting approximately 26% year-over-year growth. ARR from each of our three growth pillars accelerated in the quarter, including on an organic basis. Q1 revenue was $788 million, growing 20% year over year, 10% sequentially, and exceeding the high end of our guidance. Geographically, the Americas accounted for 58% of revenue, EMEA for 27% of revenue, and APJ for 15% of revenue. Our remaining performance obligation or RPO grew approximately 35% year over year to $5.9 billion, with approximately 47% classified as current RPO. We closed Q1 with 698 customers generating over $1 million in ARR, and 3,754 customers exceeding $100,000 in ARR, demonstrating the strategic role we play in customers' digital transformation journeys. Turning to the rest of our Q1 financial performance, our gross margin was 79.9% as compared to 80.6% last fiscal year Q1. I'd like to remind investors that we are introducing new products that are experiencing strong growth and are optimized for faster go-to-market rather than margins. This will continue to influence our gross margins on a quarterly basis. We plan to optimize new products for margins over time as they scale. Operating expenses increased 11% sequentially and 23% year over year, reaching $458 million. Operating margin was 21.8%, towards the higher end of our long-term range and growing by approximately 40 basis points year over year. Our free cash flow margin for Q1 was 52%, including data center CapEx at 2% of revenue. We ended the quarter with $3.3 billion in cash, cash equivalents, and short-term investments. Next, let me provide our guidance for Q2 and full year fiscal '26. As a reminder, these numbers are all non-GAAP. For the second quarter, we expect revenue in the range of $797 million to $799 million, reflecting year-over-year growth of approximately 23%. Gross margins to be approximately 80%, operating profit in the range of $172 million to $174 million, net other income of approximately $19 million, earnings per share in the range of $0.89 to $0.90, assuming a 21% tax rate and 170 million fully diluted shares. For the full year fiscal 2026, ARR in the range of $3.698 billion to $3.718 billion, reflecting year-over-year growth of 22.7% to 23.3%. We anticipate approximately 47.8% of net new ARR to be recognized in the first half. Revenue in the range of $3.282 billion to $3.301 billion, reflecting year-over-year growth of 22.8% to 23.5%, operating profit in the range of $732 million to $740 million, earnings per share in the range of $3.78 to $3.82, assuming a 21% tax rate and approximately 170.5 million fully diluted shares, and free cash flow margin to be approximately 20% to 26.5%. With a large market opportunity and customers increasingly adopting the broader platform, we will invest aggressively to position us for long-term growth and profitability. Before moving to Q&A, I'd like to thank Ashwin for his significant contributions to IR and strategic finance and wish him well as he transitions to his product role. I'm also excited to welcome Kim to Zscaler. With that, operator, you may now open the call for questions. Thank you. Operator: To withdraw your question, please press 11 again. Please limit yourself to one question. One moment for questions. Our first question comes from Brad Zelnick with Deutsche Bank. You may proceed. Brad Zelnick: On such a strong start to the year and hitting your Zero Trust Everywhere goal three quarters ahead is just amazing. Jay, I wanted to ask about Zero Trust Branch, which continues to hear good things about. It's showing some nice early adoption. As we look ahead, how much more work needs to be done on the product and/or go-to-market fine-tuning to see real acceleration from here? Jay Chaudhry: Thanks, Brad. We have done some amazing work on the technology side to build a Zero Trust Branch where each branch is merely an island with no lateral movement that's generally caused by traditional networking with SD-WAN and MPLS. The product is in great shape. Go-to-market, we put together a specialty team that can engage the right buyers to explain the solutions. The numbers are pretty impressive. I'll joke internally that Zero Trust Branch needs no pipeline generation effort because there's so much demand in the cost. I think we shared some numbers on Zero Trust Branch customers. We have now exceeded over 450 customers. A lot of customers start small, they do the smaller rollout, and then they move on to bigger deals. In my prepared remarks, I gave an example of a global 2,000 manufacturing customer whose ARR more than tripled. I think there are many, many such examples. We got about 4,400 enterprise-class customers. They have only gone to about 10% of them. So I see a big opportunity. I think it's an exciting area for us. And it's part of our Zero Trust Everywhere platform. Brad Zelnick: Thank you so much, Jay. Jay Chaudhry: Thank you. Operator: Thank you. Our next question comes from Saket Kalia with Barclays. You may proceed. Saket Kalia: Okay, great. Hey, guys. Congrats on the strong start to the year. Thanks for taking my questions and congrats, Ashwin. Maybe a little bit of a joint question for you, Jay, and Kevin. You know, the billion dollars in ARR that's coming from the three emerging areas is clearly outgrowing the rest of the business. In fact, I think you said it accelerated. And for good reason. But I was wondering if you could help us think about the other $2 billion in ARR. And maybe specifically, is it fair to think about that other tranche as more of a la carte Zero Trust tools like ZIA and ZPA? And maybe relatedly, how do you think about the growth rate for that $2 billion versus an emerging bucket that's clearly growing faster than the rest of the business? Jay Chaudhry: Yes, it's very true that our three buckets, a billion-dollar ARR, have been growing very well. The remaining $2 billion, yes, a big part of that is the ICPA. It has been going quite well. But the big opportunity for that business is also to emerge into Zero Trust Everywhere. Remember we said that the Zero Trust journey started with users. We're taking it to branches. We're taking it to the cloud and next to IoT OT. While other vendors who tried to claim Zero Trust tried to say we got SASE, they're merely sitting with Zero Trust trying to do for users. And we have expanded the platform to give a lot of opportunities. The core business by itself will grow at a smaller rate than the rest of the overall business. But our goal is really to take every customer to Zero Trust Everywhere. And that's what we are successfully doing. Saket Kalia: Very helpful. Thanks, guys. Jay Chaudhry: Yeah. Thank you. Operator: Our next question comes from Meta Marshall with Morgan Stanley. You may proceed. Meta Marshall: Great. Maybe just wanted to ask a question about Red Canary and just how it's kind of performing towards expectations given that you guys have been looking at a fair amount of churn within your kind of assumption for that business. Just any context around that performance would be helpful. Thanks. Jay Chaudhry: I'll start with broad comments. And Kevin can go deeper. The incubation of Red Canary at Zscaler is going very well. The GNA integration was done right away. Two other main areas were one, engineering and products. We're integrating Red Canary's agentic AI technology with Zscaler platform, doing well. Second is go-to-market. Red Canary's go-to-market team has become a security operations specialist team. It's working with our field sales organization, which is uncovering opportunity. So seeing a vast majority of Zscaler that kind of the pipeline is now coming from Zscaler customers. Kevin Rubin: Yeah. Look. I would just add that Red Canary is trending slightly better than our previous guidance. But keep in mind that, you know, we don't believe that Red Canary's contribution is material to our overall business. So as we go forward, we don't intend to provide specific color on Red Canary. Meta Marshall: Great. Thanks. Thank you. Operator: Our next question comes from Tal Liani with Bank of America. You may proceed. Tal Liani: Hi, guys. This quarter was stronger than actually you we see because if I look at the year-over-year growth in dollars, last year, first of all, 26% almost on a very strong quarter. And second, last year, on a year-over-year basis, you added between $122 million to $130 million every quarter on a year-over-year basis. And this quarter, you're adding $160 million. So that means that the growth is strong. And I'm trying to understand if you can break down on revenue level, not on ARR level, what is driving the strength. I mean, the stock is down, but the trends beneath the surface seem very strong. And I'm trying to understand what is driving it and if you can break it down, even not in numbers, if it's just qualitative to discuss what's happening in the core versus what are the key leading products that are driving this strength. Jay Chaudhry: I'll start with a broad product area. Right? As you know, we built a platform, then we're expanding the platform. The three big pillars of our platform have been Zero Trust Everywhere, AI security, and data security. All three areas are growing very well. They're actually accelerating. And that's our part of the strategy. Our strategy is if every customer starts moving to Zero Trust Everywhere, we become very, very differentiated because no one in the market is even coming close to that. They're all trying to figure out how to solve the user side of it. And the data security, our customers are basically saying, we are tired of seeing point products, so many point products in data security. We are the best platform. AI security is evolving. It's a new area for us. Agentic operations have done well for us. And security of AI products is growing pretty well. So I think they're very pleased with that. Growth we wanted from three key pillars. And it's exceeding our expectations. Kevin, you want to give him more color? Kevin Rubin: Yeah. Thanks for the question, Tal. I mean, I think that's frankly, both the qualitative and the quantitative response, which is we are seeing accelerated growth in our three growth pillars, is contributing, you know, well to the business. I also mentioned in my prepared remarks that we saw organic growth come in at similar levels to what we saw last quarter. So we are seeing very strong performance. And the business did come in better than our internal expectations in the quarter. Tal Liani: Uh-huh. And how is the core business? You have Cisco with the new product, Check Point with the new product, Palo talking about very strong growth. How is the competitive landscape when it comes to the core business? Jay Chaudhry: The competitive landscape hasn't changed a whole lot, if anything else. Our brand has gotten bigger. Most of the large enterprises know us very well. We are very well engaged here. A number of new entrants who have come in the market in the past year or so. Largely some of the firewall companies, we have hardly seen them out there. So the competitive landscape hasn't really changed much to mention. Tal Liani: Got it. Thank you. Jay Chaudhry: Thank you. Operator: Our next question comes from Joseph Gallo with Jefferies. You may proceed. Joseph Gallo: Hey, guys. Thanks for the question. Jay, I think when some look at the recent massive M&A in the space, they're fearful of the implications for underlying cyber growth. In your conversations with customers, how are they thinking about spending in calendar 2026? And what are the priority areas that they have as a part of that? Jay Chaudhry: So customers' priorities for spending? Yes. Just, you know, with the how is the fund cyber growth been? Yep. How do you expect it next year and what the priorities are? Broadly speaking, there's no significant growth in the back environment. IT budgets remain tight. There is pressure on CIOs. There is far less pressure on the cyber side of it. So cyber is under less pressure. We do see scrutiny from our deals, similar to what we shared in the past. But two areas are still of high interest to customers. One is zero trust security because all these breaches happening out there. And second is AI security because everyone is trying to do some level of deployments of AI applications because CIOs feel like if they aren't doing anything in this area, they'll be viewed as laggards. That is also mixed. Some of the customers are seeing better results than others in terms of AI. But as soon as they start thinking about doing AI applications and models, the security becomes a worry for them. So we are going in with two leading messages: Zero Trust Everywhere being one, and AI security being two. So with that, we're able to get the pipeline created. And the second part is to close deals, we must show strong cost takeout. And we can do that as we eliminate a lot of point products. So we are able to do both of those things. That's what's really leading us to deliver these strong results. And also, if I mentioned that, since our brand has become so much stronger, and we've become pretty strategic partners to customers, all these CIO, CSOs meetings I do, it's wonderful to see them. To say, hey. I mean, we moved from company A to company B. And we called your team to help us here as well. So look, we are tracking well. We're excited about what lies ahead for us. Joseph Gallo: Thank you. Operator: Thank you. Our next question comes from Mike Cikos with Needham. You may proceed. Mike Cikos: Great. Thanks for taking the questions here, guys. I just wanted to come back to the SASE market specifically. And, Jay, I know you're probably already cringing at the word SASE, but just there was a lot of security vendors out there last week discussing some success and competitive displacements in the SASE market. Just wanted to get your feedback specifically on what you're seeing as far as trends from a competitive or pricing discipline standpoint. Appreciate it. Thank you. Jay Chaudhry: Look. We demand very strong in when it comes to, I will call, the Zero Trust market. Because the SASE keyword has no meaning. Every vendor claims until to be calling SASE. For example, if you do Zero Trust, you don't do SD-WAN. And most of these SD-WAN vendors can be viewed into the SASE phase. Our expansion in our customer base is because of all the new functionality we are bringing to take Zero Trust Everywhere. Our expansion is happening as we have taken our data security platform and made it much bigger. So we've done so many innovations in so many spaces. So we think in spite of new entrants in the market, I think the market has already kind of sorted out the winners, and we are creating more distance among the number of the vendors. Well, sorry. Among the number of other vendors who are entering the space. So I feel very strong. Our pipeline remains strong. Our win rate remains strong. And you see our results, they're very, very strong. Mike Cikos: Perfect. Thank you. Operator: Our next question comes from Brian Essex with JPMorgan. You may proceed. Brian Essex: Hi, good afternoon. Thank you for taking the question. I guess, Kevin, for you, you know, just I understand that you don't want to break out Red Canary, but can you give us a sense for organic net new ARR in the quarter? And then maybe one for Jay. With the acquisition of Red Canary and what you've done with Avalor and now SPLX, love to get your sense of, do you have any sense of how you might align with the threat intelligence market and value you might be able to add given the data visibility, potential for incremental add in terms of the quality of data that you might be ingesting on the platform and ability to provide better visibility to customers on the threat intelligence side? Kevin Rubin: Of course. Thanks for the question. I'll go ahead and start. As I had previously mentioned, organic growth in Q1 was consistent compared to Q4. And again, as I said, we're very pleased that the organic business came in better than our internal expectations. Jay Chaudhry: So on the second part, we talked about two acquisitions we have had. Avalor has become our data fabric, which can ingest data from the Zscaler platform and some of the third parties to really create what we call entity relationships. And, you know, AI is only as good as data, so we're able to do some very harmful threat detection intelligence that couldn't be done otherwise. So that's the foundation of the platform. The reason for us to get into AI-powered setups is the strength of our data. Avalor gave that stuff. We have the data. Red Canary gave us a gigantic AI technology on top of it. So using some of these smart agents, we can do security operations. What security analysts need to do, so the amount of information we are getting, the meaningful intent we're getting is unbelievable. I was talking to the CSO of a Fortune 100 company recently. He said, I have a sizable security operation team, very sophisticated operations. But your solution, in this case, they're taking advantage of Red Canary working with us. It is finding things, a few things every month that we aren't able to find. That's amazing. Incremental value for them. We think this is only going to get better as our solution evolves. Your second point of the SPLX, that's accelerating our completion of solution for AI security. The market has so many point product solutions in AI security out there. And customers tell me, one, I don't want to deal with 10 vendors, number one. Number two, I don't want to share my data with a startup that started ten months ago to share with them. So they're looking for a platform. We have built a number of AI security platforms internally. For example, GenAI Security, AI Guard, AI Discovery, and SPLX brought red teaming technology to us. So it had made our portfolio pretty complete. So Zero Trust Everywhere in a very great shape. Agentic operations evolving nicely and AI security operations growing very nicely. We feel very comfortable with the portfolio built. Brian Essex: Got it. Helpful. Thank you. Operator: Our next question comes from Shrenik Kothari with R. W. Baird. Yeah. Thanks for taking my question. Shrenik Kothari: So, Jay, on the AI security tracking, $100 million, and you mentioned traction across all the modules, AI Guard, SPM, with teaming. Just can you help us unpack where there's more traction, what's currently driving in terms of use cases, are most deployments as at visibility governance via SPM, or are you seeing CSOs truly prioritizing all the runtime AI with AI Guard as well? And then I have a quick follow-up. Jay Chaudhry: Yeah. This is a very good question. About two years ago, two plus years ago, when ChatGPT came on the scene, the number one thing customers wanted to do was visibility into GenAI solutions or, sorry, applications that users are going to go to. Since we are sitting in the traffic path, very quickly we built our first product, GenAI Security. That's being used by quite a large number of these customers. Next, we launched AI asset discovery and posture management. Tons of interest because everything starts by understanding AI assets you have. Third, last summer, early summer, we launched AI Guardrails. When customers are building their internal AI applications and models, they want to use guardrails to make sure that models are protected and only the right people with the right kind of prompts can easily access them. That's an early stage, but it's growing nicely. The pipeline is growing very well. And the fourth thing we brought to the market came through SPLX acquisition. That's core red teaming technology. And as applications are being built, customers want to make sure they don't have liabilities. And we aren't stopping there. The fifth is extending our platform to enchanting exchange so we can have the right agent-to-agent to agent-to-application communication. All that is proceeding well. So I think we are very well positioned. We will keep on investing in these innovations. But we balance our investments with our operating margins. Shrenik Kothari: Very helpful, Jay. Just Kevin, a quick follow-up on your comment around these modules ramping, as Jay was saying, how are you thinking about the investment horizon overall and as you're scaling these compute-rich products, AI Guard, and how to think about the margins here? Kevin Rubin: Yes. Since the models and things they're using are really on them. On a fairly well-confined set of data, we haven't seen any massive change in gross margins. If these things change over time, I'm sure we'll let you guys know. And maybe just to continue on that thread. You know, look, for Q1, we're pleased with the margin profile. We're comfortable with the Q2 guide. And then as we look into the back half of the year, you will notice that there's margin expansion in the guide in the back half. We are orientated to growth, but you know that we're also very mindful of the financial model and operating margin. Shrenik Kothari: Thank you. Operator: Our next question comes from Roger Boyd with UBS. You may proceed. Roger Boyd: Great. Thanks for taking the questions. Jay, I just wanted to go back to Zero Trust Gateway. And I wonder if you could talk a little bit more about the demand you're seeing there. Is that product getting pulled along with increasing AI infrastructure? Some of the firewall vendors have talked about growth in software firewalls in this capacity. And how are you thinking about customer buying around this approach over kind of that approach of deploying virtual firewalls? Thanks. Jay Chaudhry: Sure. As you know, customers have traditionally used firewalls everywhere. We replaced a lot of them when it comes to user protection. And work on branch and cloud is pretty simple. When traditionally people would go to the cloud and build cloud workload, they would do left-hand shift. They have left-hand shifted, not so far, also the problem has VMs. They're lift and shifted east-side firewalls to the cloud as VM as well. We go in and say, you don't really need a lot of these firewalls everywhere. Zero Trust Cloud is almost like Zero Trust for Internet access, zero trust workload to work on communication. All the firewalls go away. Customers do not need to work with all these IP addresses and ACLs. The cloud gateway simply makes it even easier to deploy our solution. In the past, they had to deploy a piece of software we call Cloud Connector as a traffic cop. Now, we have a cloud gateway that's deployed and managed by Zscaler. With a simple config change that says, point traffic to Zscaler cloud gateway. And we enforce policies, and we do everything that needs to be done. Deployment that would have taken a few hours now can be done in under ten minutes. That's the kind of innovation we're bringing to make it easier for customers to move away from legacy firewalls and embrace Zero Trust cloud workload communication. Roger Boyd: Thank you. Operator: Our next question comes from Eric Heath with KeyBanc. You may proceed. Eric Heath: Hey, great. Thanks for taking the question. Maybe to come back to Zero Trust Everywhere just given how strong and successful it's been thus far. But I'm curious to hear how you're thinking about this going forward. I mean, is the outperformance relative to your expectations because the book of firewall business up for refresh maybe was bigger or earlier than you anticipated or do you look at the pipeline and see an even bigger opportunity of displacements looking into calendar '26? Thanks. Jay Chaudhry: Overall, our customers are looking for saving money and making it easier for them to operate and deploy these solutions. And along with that, making sure they have better cyber protection. The number one reason for customers' interest in the Zero Trust Branch is to eliminate the lateral movement which leads to all kinds of ransomware attacks. Number one. Number two, when we go in and say, by the way, it's also costing a lot more because we can eliminate multiple products in a branch. Not just firewall, but SD-WAN. Often, they got these DHCP gateways. They often got east-west firewalls. They got NAT convenience kind of stuff. All of that goes away. So cost goes down. Operational stuff goes down. That's a driver. That refresh may help, but most of the time, the deals are not waiting for Zscaler to say refresh is coming. As we present the story to our customers, they kind of say, wow. This makes sense. There's a lot of ROI to it. Get started. So tremendous interest, strong pipeline, and we've only done about 450 customers so far. There are millions of branches left out there for us to pursue. Eric Heath: Thank you. Operator: Our next question comes from Fatima Boolani with Citi. You may proceed. Fatima Boolani: Good afternoon. Thank you so much for taking my questions. Jay, I wanted to go back to a very specific remark. In your script earlier in the call. Just with respect to the migration of SAP from on-prem to SAP Rise being an opportunity that would be tantamount to the success and the tailwinds that you saw from Microsoft Exchange going to Microsoft March. And so I wanted to take the opportunity to have you unpack some of that in terms of how will that manifest in your business across the product lines today? And then specifically, you know, with the portfolio that is significantly larger today than you had when this the initial Microsoft platform migration was happening. Where do you expect to see sort of the I'll frame it as option value in some of your newer products that frankly didn't exist? In the last sort of precedent example. Jay Chaudhry: Sure. You know, the customers moved to Office March several years ago because Office moved to the cloud or Exchange moved to the cloud. But SAP has taken a long time. It's a far more complex application. But now SAP is pushing for deployment of what they call SAP RISE in the cloud and telling customers that you got to move, and they're giving some incentives as well. So if you do the old way using the legacy firewall technology and network, you move SAP RISE to the cloud, then you really then deploy all these express routes and direct connects for connectivity. And then you've got firewalls and all the stuff you deploy to access those applications, the VPN type approach. We go in and say none of that stuff is needed. No special access routes and direct connects needed. You can access SAP RISE applications with Zscaler directly over the Internet as you access Office 365 applications. It's a clean, simple, elegant architecture. So it gives us two opportunities for us. Number one, some of the cloud zero to cloud technology to make sure we got protection and communication for SAP application, SAP RISE itself. Second, for users to access SAP, with better and faster experience. Those are the two areas of growth for us. And it helps a customer deploy and get the application running faster. And it reduces cost and gets great user experience. Fatima Boolani: Thank you. Operator: Our next question comes from Gray Powell with BTIG. You may proceed. Gray Powell: Great. Thanks for taking the question. Yes, it's really interesting this quarter. I mean, I look at the numbers, and overall, everything looks good. I do think there's some confusion on just organic ARR. So I guess here's my question. You highlighted $175 million in Flex bookings this quarter. Compares to RPO bookings at about $940 million. So basically, Flex is now 20% of the mix. It almost doubled versus last quarter. Where do you see that going longer term? And then as Flex becomes a bigger component of bookings, does that give you higher visibility on future period ARR because there's just inherently an installed ramp in those contracts as customers grow out? Kevin Rubin: Yeah. Great. So I'll start and Jay can add anything that he may want to share. Look. I appreciate you raising Z Flex. It is a program that has gotten a lot of interest and traction from our customer base. To your point, we did see bookings grow over 70% sequentially. And it effectively allows customers to commit to spend. We typically see that as a more commitment than they would have made on an a la carte basis. It allows them to easily deploy additional modules without having to go through the friction of a negotiation procurement process. And then it provides them with the flexibility to swap in and out of modules as business dynamics for those customers change. And so it gives them confidence that they can make more meaningful commitments to us and generally over longer periods of time. It doesn't have, necessarily a different impact to ARR than any other type of transaction. But to your point, it does give us greater visibility over the long term. Because they are longer contracts. We do understand the nature of those commitments and how they play out in the future. And I would say, it's frankly a win-win for both the customer, and the flexibility it offers, and us in terms of the visibility going forward. So it is a very powerful tool that has gotten, you know, pretty significant interest from customers. Jay Chaudhry: Yeah. I would say our business has performed very well on all metrics. They are on cash flow, all areas. So we're very pleased with it. Operator: Thank you. Our next question comes from Joshua Tilton with Wolfe Research. You may proceed. Joshua Tilton: Hey, guys. Thanks for sneaking me in, and congrats to Ashwin. Just one for me, and apologize if this was addressed already bouncing back forth between a few calls. But, did your assumption for what Red Canary contribute to the full year ARR change at all? And if not, is it fair to assume you raised ARR by for the full year is how much you outperformed organically in the first quarter? Kevin Rubin: Yes. Thank you for the call. I did make a comment earlier. We are seeing Red Canary trend slightly better than our previous guidance. But, as a reminder, we don't believe that Red Canary's contributions to our overall business are material. So we're not going to be making color commentary with respect to Red Canary going forward. With respect to the outperformance, I mean, we did pass that through the full year guide. But I think to further clarify, you said that before. Organic growth in Q1 for us was consistent as compared to Q4. Very pleased with it. It beat our internal expectations. Joshua Tilton: Thank you. Operator: Our next question comes from Jonathan Rukaver with Cantor. You may proceed. Jonathan Rukaver: Yes. Hi. Good afternoon. Jay, I'm curious to hear your thoughts on the synergies you see between Red Canary and the, you know, the data security portfolio. It would seem that you know, you have opportunities around remediation, a possible governance layer, for DSP and DLP. Can you just provide an update on that integration strategy? And maybe just a little bit of color on how you see that driving differentiation relative to you know, all the other vendors that are targeting data security capabilities related to AI. Jay Chaudhry: Yes. Very, very good question. I would mention three points there that set us apart from many others. Number one, we have built a full portfolio of data security. There's no such thing as data security, but AI only. Data is lost in many ways. So number one, the strongest portfolio is helping us. Number two, AI is helping us doing better data classification. Which is important because better classification means better detection. Number three, the other point you made, it was a Red Canary synergy. That is the following. We are able to get all the signals from Zero Trust Exchange to our data fabric platform where we are able to potentially look for any potential threats or breaches or any of the stuff that's happened. And if they're able to do that very quickly, we can do a closed-loop feedback sent to a Zero Trust Exchange if you need to walk some kind of data loss that's happening out there. Today, data loss happens. Signals are found. Days or weeks later. This closed-loop system between our agentic operations and inline function is a clear, clear differentiator for us that should set us apart from many other vendors whether they're SASE vendors, or they are AI security vendors. Operator: Thank you. And our last question comes from Matt Hedberg with RBC. You may proceed. Matt Hedberg: Great. Thanks for taking my questions, guys. Congrats on the results, really. I wanted to follow-up on, I think it was Gray's question on Z Flex. It really does show up in checks. And I think, Kevin, you mentioned reducing friction. Additional consolidation opportunities. I realize it's difficult, but is there a way to think about what that average Z Flex upsell looks like? And then maybe just a little bit more color on how do you think about the pipeline of Z Flex deals for the rest of fiscal year? Thanks, guys. Jay Chaudhry: So first of all, Z Flex was done to give our customers flexibility. It evolved from the traditional ramp deals we had done in the past when we go after a lot of customers. They can deploy it overnight. And if they bought lots of modules, they wanted some ability to say, give me some RAM because I won't be working on it. We have been doing RAM deals for quite some time, but this creates a formal program around it. The second thing it's created for us is the ability to swap modules so they don't have to keep on testing various modules for a long time and delaying the deal. So we believe that the deal ability to close deals has gotten better. And three, the ability to do larger deals has gotten better because now they know that they can swap deals, modules, so they can go for a bigger deal. All these things are happening. I'm not sure we have quantified exactly how much impact it is happening. But we are seeing good results of it. So we are pleased with the performance. Kevin, you want to add anything? Kevin Rubin: The only thing I would, again, I guess, express is you see growth in customers moving into Zero Trust Everywhere, which you see adoption of data security everywhere and AI security, a lot of that momentum and the facilitation will come from programs like Z Flex that will make it easier for customers to adopt these technologies. And so, for us, we think it's just a stimulus to allow customers to more easily and friction-free adopt more of our technology. Operator: Thank you. I would now like to turn the call back over to Jay Chaudhry for any closing remarks. Jay Chaudhry: Well, thank you for your time. We look forward to seeing you at one of us or some of the investor conferences. Operator: Thank you. This concludes the conference. Thank you for your participation. You may now disconnect.
Operator: Good day, and thank you for standing by. Welcome to Fluence Energy's Fourth Quarter 2025 Earnings Conference Call. [Operator Instructions] Please note that today's conference is being recorded. I will now hand the conference over to your speaker host, Chris Shelton, VP of Investor Relations and Sustainability. Please go ahead. John Shelton: Good morning, and welcome to Fluence Energy's Fourth Quarter and Full Year 2025 Earnings Conference Call. Before we begin, I want to share my excitement as our new Investor Relations Officer. I look forward to engaging with our analysts and investor community. I would also like to recognize Lexington May, who has recently taken on a new role at Fluence. Lex has been instrumental in leading our Investor Relations program since our initial public offering and its contributions have greatly benefited our company and its shareholders. Joining me on this morning's call are Julian Nebreda, our President and Chief Executive Officer; and Ahmed Pasha, our Chief Financial Officer. A copy of our earnings presentation, press release and supplementary metric sheet covering financial results, along with supporting statements and schedules, including reconciliations and disclosures regarding our non-GAAP financial measures are posted on the Investor Relations section of our website at fluenceenergy.com. During the course of this call, Fluence management may make certain forward-looking statements regarding various matters related to our business and companies that are not historical facts. Such statements are based upon current expectations and certain assumptions that are, therefore, subject to certain risks and uncertainties. Many factors could cause actual results to differ materially. Please refer to our SEC filings for our forward-looking statements and more information regarding certain risks and uncertainties that could impact our future results. You are cautioned not to place undue reliance on these forward-looking statements, which speak only as of today. Also, please note that the company undertakes no duty to update or revise forward-looking statements for new information. This call will also reference non-GAAP financial measures that we view as important in assessing the performance of our business. A reconciliation of these non-GAAP measures to the most comparable GAAP measures is available in our earnings materials on the company's Investor Relations website. Following our prepared comments, we will conduct a question-and-answer session with our team. During this time, to give more participants an opportunity to speak on this call, please limit yourself to one initial question and one follow-up. Thank you very much. I'll now turn the call over to Julian. Julian Jose Marquez: Thank you, Chris. I would like to send a warm welcome to our investors, analysts and employees who are participating in today's call. This morning, I will review the highlights of our fiscal '25 results, the accelerating demand for energy storage and how Fluence is positioned to lead in this growing market. I will also provide an update on our product road map, our domestic content strategy and progress towards all BBBA compliance. Ahmed will then cover our financial results and '26 outlook. Turning to Slide 4 and our financial performance. First, I am pleased to report that during the fourth quarter, we signed more than $1.4 billion of orders, which represents a record level. This brings our current backlog to $5.3 billion, setting us up for renewed growth in '26 and beyond. Second, full year revenue came in at approximately $2.3 billion, about $300 million below our expectations, mostly due to delays by our contract manufacturer in ramping up our newly commissioned Arizona enclosure manufacturing facility. We have implemented corrective actions. Production is improving, and we are confident in meeting delivery commitments and capturing the shortfall during fiscal '26. I will discuss these details further in a moment. Third, despite this revenue impact, we delivered a record of approximately 13.7% adjusted gross margin for the year and approximately $19.5 million of adjusted EBITDA, which was at the top end of our guidance range. These results were the product of good execution on projects and cost efficiencies. Fourth, in terms of annual recurring revenue or ARR, we ended fiscal '26 with $148 million, slightly above our original guidance of $145 million. And fifth and finally, we ended the quarter with approximately $1.3 billion in liquidity which puts us in a strong financial position to fund our plans for growth. Please turn to Slide 5 for details on our order intake and pipeline. Our record $1.4 billion of order intake during the fourth quarter included contributions across all our core markets. Approximately half were for projects located in Australia. For fiscal '26, we currently expect the U.S. market will be the largest contributor of order intake as reflected by our pipeline as of year-end. Looking ahead, demand for energy storage solution is accelerating worldwide, driven by both the rapid decline in capital cost of storage and surging demand for electricity for intermittent renewables, data centers and industrial complexes. We have seen a significant increase in larger deals in our pipeline that as of September 30, includes 38 deals of at least 1 gigawatt hour, more than double the number from last year and nearly 5x what we saw 2 years ago. Please turn to Slide 6. Earlier this month, we announced a landmark 4 gigawatt hour project with LEAG, representing the largest battery project in European history. These projects will use our new Smartstack product and play a key role in Germany's energy transformation. We are very pleased to welcome LEAG as a customer and look forward to supporting additional energy transformation projects across European markets. Please turn to Slide 7 for other emerging drivers supporting our pipeline growth. We have seen significant pickup in demand from data center customers. We are currently in discussions with data center projects representing over 30 gigawatt hours. 80% of these engagements have originated since the end of the quarter. Fluence is ready to lead in this emerging market segment with Smartstack industry-leading density, reliability and safety in addition to its lower cost of ownership. Another set of emerging opportunities is long-duration storage, which is driven by the need for 6- to 8-hour duration batteries in markets with significant renewable penetration, such as Europe and California. Specifically, in Europe, regulatory schemes are in place to procure this capacity. Today, we have line of sight into 60 gigawatt hours of long-duration storage tenders. Smartstack is well suited to compete in this segment due to its flexible architecture and a scalable design. Please turn to Slide 8 for an update on our team. To capture the opportunities I have just described, we have sharpened our focus on sales and flawless project execution. To that end, we are excited to welcome Jeff Monday as our new Chief Growth Officer. Jeff leads our global sales and marketing teams. He brings deep experience from Qualcomm, where he built their global enterprise and channel sales teams. Prior to that, Jeff spent 18 years leading sales teams at Apple. His expertise will help us expand the reach of Fluence's brand to new customers and industries, such as the tech sector. In addition, we have also expanded John Zahurancik's role as Chief Customer Success Officer. As one of our company's founders and an industry pioneer, John will leverage our record of successful execution to further differentiate Fluence from our competition. He will also maximize the value of our solutions for our customers with our digital and services offerings. We believe that these internal changes will streamline our customer experience and position us to win a larger portion of our pipeline. Please turn to Slide 9 as I discuss our new Smartstack product. We are pleased with the market reception of Smartstack. In addition to its role in winning our LEAG deal, this month, we are deploying the first Smartstack units in a project site in Taiwan. We designed Smartstack with the objective of reducing total cost of ownership for our customers. This means in addition to a lower sales price, Smartstack offers lower cost to install and maintain the system over its useful life with top-of-the-line operational metrics. Smartstack is the only product available today that offers battery density of 7.5 megawatt hour per unit, letting customers see over 500 megawatt hours of storage per acre. That means bigger projects, optimized sites and better economics, all else equal. Additionally, Smartstack maintains all elements of fire safety and cybersecurity that have been historically a salient element of our offering. Finally, Smartstack is developed with a flexible system architecture that can adapt to customers' specifications. We expect this will be a key selling point for data centers as technology to reduce system latency evolves and Smartstack kits can be upgraded with new equipment quickly on site. We are engaged with many customers interested in Smartstack and expect it will represent a majority of our orders for this fiscal year. Please turn to Slide 10 for an update on our domestic content strategy. Our domestic supply chain is a critical advantage for our business, particularly given that we see the majority of our growth coming from the U.S. market. We have contracted with 3 key production facilities located in Tennessee, Utah and Arizona. The Tennessee and Utah facilities produce our battery cells and modules, respectively, and they have successfully met production metrics in line with our expectations at the time of our last earnings call. The Arizona facility, which manufactures enclosures, has not met its production targets during this period. Without those enclosures, we were unable to deliver our completed products and recognize the corresponding revenue during the fourth quarter. The primary cause of the manufacturing delay has been the slower ramp in staffing the facility, especially for weekend shift. We have been working with our contract manufacturer to execute a plan to improve staffing levels and further optimize the workflow. As of today, the production rate has improved and staffing levels have in great measure been met, which give us confidence that the manufacturer will meet our desired target rate by the end of this calendar year. We expect to fulfill all of our customer delivery commitments over the course of '26 and book the associated '26 mix revenue. We will continue to work with our U.S. manufacturers to scale production and maintain our leadership position. We are committed to serving our U.S. customers with a competitive domestically manufactured solution. Please turn to Slide 11 for an update on our prohibited foreign entity or PFE compliance strategy. A quick refresh. The One Big Beautiful Bill or OBBBA included regulations designed to restrict tax credit availability for products manufactured in the U.S. but supported by companies deemed to be PFEs. To that end, our strategy aims to meet our growing volume demand for domestic content from a diverse set of qualified suppliers. I am pleased to report significant progress. More specifically, this month, we have secured a second supplier for domestic battery cells. This manufacturer is compliant with all OBBBA regulations and further derisk our future growth. Turning to our Tennessee facility. We continue to work actively with AESC to find a comprehensive solution to comply with PFE regulations. The 3 key pieces to achieve non-PFE status include transfer of ownership, IP and material assistance. Significant progress has been made in addressing all these 3 items. The option of Fluence purchasing the facility from AESC remains under consideration as a possible solution. We continue to view the incremental financing need of a potential transaction as being manageable within our available liquidity. Both parties are motivated, and we continue to expect a constructive resolution in advance of the effective dates specified by the law. I will now turn the call over to Ahmed to discuss our financial results and fiscal '26 guidance. Ahmed Pasha: Thank you, Julian, and good morning, everyone. Today, I will review full year 2025 financial results and our liquidity position, followed by a discussion of our fiscal year 2026 guidance. Starting with Slide 13, covering fiscal year 2025 performance. Over the course of the year, we generated revenue of around $2.3 billion. As Julian mentioned, this figure falls short of our expectations by $300 million, largely due to a slower-than-anticipated ramp-up at one of our contract manufacturing facilities in Arizona. While this shortfall was a challenge, I want to highlight that our disciplined execution and operational focus enabled us to deliver on our profitability and bottom line objectives. Regarding production, most of our U.S.-based contract manufacturing facilities have been operating at their targeted capacities, including both cell and module manufacturing. However, the newly commissioned enclosure facility in Arizona faced some challenges, primarily due to the longer lead time to attract and train the workforce necessary to drive productivity. This was the primary factor behind the lower-than-expected revenue in the quarter. Working in collaboration with our contractor, we have seen significant production improvement since September. The majority of personnel required to execute our plan have now been hired, and we are on track to achieve our targeted production levels. Our adjusted EBITDA for the year was $19.5 million, which came at the top end of our guidance range even as revenue fell short of expectations. This outcome underscores our operational excellence and strong execution. Turning to Slide 14. We achieved a record level of 13.7% adjusted gross margin for the year, above the top end of our expectations. In addition, our rolling 12-month adjusted gross margin is consistently at or above 13%. This reflects our strong focus on productivity and successfully leveraging our supply chain. Turning to Slide 15. We also finished the year with a record of approximately $1.3 billion in liquidity, up $300 million compared to the end of fiscal 2024. This includes more than $700 million in cash with the rest available through our credit facilities. This strong position gives us confidence to make investments that will grow our business and strengthens Fluence's reputation as a reliable partner. Looking ahead to fiscal 2026, we intend to invest about $200 million in our business. This includes approximately $100 million in our domestic supply chain and the rest in working capital to support 50% revenue growth. Turning to Slide 16. Today, we are introducing our guidance for fiscal year 2026. We expect revenue in the range of $3.2 billion to $3.6 billion. We began this year with 85% of our guidance midpoint already in our backlog. This strong coverage materially derisks our FY '26 revenue compared to the historical level of around 60%. We anticipate realizing 1/3 of this revenue in the first half of the year and the rest in the second half. We expect our adjusted gross margin to be between 11% and 13%. This range reflects a period of higher costs associated with the rollout of our Gridstack Pro product, which will make up 70% of our 2026 revenue. We anticipate margin will improve over time as we continue to leverage our disciplined execution and our growing scale. We expect operating expenses to grow at less than half of the pace of revenue, consistent with our guidance in prior years. This includes increased spending on sales, marketing and R&D to support future revenue growth. For adjusted EBITDA, our guidance of $40 million to $60 million reflects expected revenue, adjusted gross margin and higher operating costs from planned investments in sales and product initiatives. With respect to ARR, we are initiating guidance of approximately $180 million by the end of fiscal '26, representing over 20% year-over-year increase. In summary, with our strong liquidity, focused execution and robust order book, we are well positioned to deliver on our plan. With that, I would like to turn the call back to Julian for his closing remarks. Julian Jose Marquez: Thanks, Ahmed. Before we take your questions, I would like to conclude with the following 5 takeaways. Market leadership. Demand for energy storage is accelerating globally. Fluence is capitalizing on this environment with notable wins such as the 4 gigawatt hour LEAG project in Europe and a rapidly growing pipeline of data center customers and other large-scale deals. Product leadership. Smartstack is a key differentiator versus the competition. With increased density and a very competitive total cost of ownership, we expect Smartstack to drive a majority of future orders. Operational execution. We have made significant progress to strengthen our domestic supply chain advantage. We have addressed production issues at the Arizona facility, and all our domestic manufacturers are now on track to meet our expectations. Compliance and readiness. We have strengthened our ability to deliver PFE compliant products to customers with the addition of a second domestic battery cell supplier. We continue to make progress towards OBBA compliance with our Tennessee manufacturer and expect resolution ahead of regulatory deadlines. Looking forward, these achievements position us to maximize stakeholder value by consistently meeting our commitments to customers and shareholders, reinforcing our reputation as a trusted industry leader. Operator: [Operator Instructions] Our first question coming from the line of George Gianarikas with Canaccord. George Gianarikas: I'm just curious if you can share any thoughts on what you're seeing in the competitive environment? Any changes there in the U.S. and internationally? Julian Jose Marquez: Internationally, not real change. It's a very competitive market, and the Chinese players continue to drive the competition in a way. The U.S., the competitive market is changing with -- we see more and more customers that prefer to use U.S. or non-PFE manufacturers, even if they're not required to do it under the -- because the projects are safeguarded under the law or of that provision. So I would say that, but it's an evolving matter that we see coming. So that's kind of today where I see the market. George Gianarikas: And maybe as a follow-up, Ahmed, I think I heard when you were talking about gross margin or margin guidance for '26 that you expect margins to improve over time. Were you referring to gross margins moving beyond the 11% to 13% range you guided for next year, say, in '27, '28? Ahmed Pasha: Yes. George, yes, I think our goal is to continue to improve the chart that we have disclosed. I think our goal is to continue to show that chart going forward to show the trajectory and the difference we are making. Our guidance, as you recall, was 10% to 15% in the past. I mean, I think our -- we haven't changed that going forward. So our goal is to continue to improve that trend line. Operator: Our next question coming from the line of Brian Lee with Goldman Sachs. Brian Lee: Kudos on the quarter here. Just I appreciate all the color, Julian, on the data center sizing. It sounds like that opportunity is coming to fruition here pretty quickly given the time line you expressed. But can you maybe help us a little bit understand, first, the sizing of the market, I guess, if we take the 30 gigawatt hours of data center projects in the pipeline and leads, that's maybe if we estimate maybe $6 billion of the total $23 billion pipeline or in that neighborhood. Is that kind of the way to think about it? And what do you think the overall TAM is and what Fluence's market share could ultimately end up looking like? Julian Jose Marquez: Good question. Let's start with the TAM. Last quarter, we talked about a TAM of around $8 billion. So I think that it's clearly -- the reality is proving that the number is significantly higher. The market has still very, very different numbers. I said we have seen numbers of the 10 times the $8 billion or more than 10 times the $8 billion. It's still unclear. We have to, I think, a little bit more. But clearly, it's a market that is expanding. Of the 30 gigas that we talked about, as of September 30, only 20% of it, one small portion were in our pipeline. The rest were contracts that we started to -- with customers since then. And then today, if you ask me today this morning, roughly half of the 30 gig are in pipeline, the other half we're working on it. And what we're looking is -- will they happen in the next 2 years, where do we see our product is suitable to do what they want. And generally, I think we are fine. So what's a big change from telling you a quarter ago, this is an $8 billion market requiring this very, very complex capabilities to today. I think there's a big change in terms of what we can do for what our technology and Fluence in particular, can do for data centers. And I would say the way to think about it is that there are 3 needs. One is what we call interconnection flexibility, the ability to manage your -- the energy demand in a way that you can interconnect easier to the grid and you can manage and the distribution companies or the service provider can manage your demand to keep the -- so that is by itself, I would say, today, the biggest driver. People who want to connect quickly to the grid and want to ensure that the data center meets the availability of the grid and can give the assurances to the grid operator that they will not disrupt the grid. And we can do that today. That's what work. This is -- there's no -- we have no need to improvements in our technology stack to be able to do it. So great. The second one that is also in a rising need or rising need is backup power. Historically, we haven't played that game. But with our costs coming down as they are and our ability to -- our density improvements, we can now provide backup power and significantly reduce. I won't say eliminate, but significantly reduce the need for diesel generators. So that's the second need that we're seeing. We can accelerate interconnection to the grid, and we can reduce some of the cost of the diesel generators by providing backup power. The third one is the one we have talked about in our last call, this power quality, this idea that we can -- we will have to manage the variability of energy demand by AI data centers. That -- if you ask me today, that hasn't been -- the first thing is that there are other technologies that can address that. That's the first one. The second one is that it is a need that is not as big as we thought it was going to be. So it's probably around that $8 billion number. And it is something that data centers, when they look at what they're doing, their speed to power is a much more important element than this one because the other one they can manage in some other way. We are committed to delivering the 3 products. The interconnection flexibility to accelerate interconnection, the backup power capabilities. And these two that we can do today, and we're very well positioned to do. Smartstack is the densest project in the world. It is a project that because of the [indiscernible], the way we are designed provides very good safety, better than, I would say, very, very good. And then third, our cybersecurity, our total control on software, our ability to ensure that no one else can get it. So the power quality is something we're working on with our inverter manufacturers. We'll get it resolved quickly, but it's still a work in progress. But we thought that was going to be a gating item the backup power is going to be a gating item for us to serve this market. That's no longer the case. I would say it's a cherry on the top. If you can deliver the last 2 and this one is great, but it's not a gating item. So great market, multiples of what we told you in terms of what we do, and we don't need to do a major technology. And my last point, we can -- we don't have a clear view today. This is just starting on how much we can capture. What I will say, we are very well positioned to do safety, density. Some of our competitors are claiming density, which is 20% to 25% less than what we can do. So that tells you we can do very, very well, and we are -- we have -- we hired Jeff. Jeff comes with knowing how to serve this market. He's been one of the structure, go and get this done. And this is not only happening in the U.S. This is a global phenomenon. We have in our pipeline. It's mostly U.S. today, but we're starting to see pipeline coming both out of Australia and Europe. So sorry for the long answer, but that we're excited about this opportunity. Brian Lee: Yes. No, I can definitely sense that. I appreciate all the color. Maybe just one more question on that topic. From a P&L timing and impact perspective, can you give us a sense of the conversion time line for this data center pipeline? And is any of it embedded in your revenue guide for fiscal '26? And maybe just lastly, margins relative to core margins. Are these going to be higher margin just given the customer subset you're dealing with? Curious on the impact on margins as well. Julian Jose Marquez: I'll say that of the 30 gigas, half are '26 order intake, half of our '27, give or take, and most likely projects that will be -- will convert into order intake later in the year, not revenue for '26. We have to see how much revenue for '27 is unclear. In terms of margin, this is a new segment. I don't want to talk about it publicly. But what I will say is that we can provide a lot of value to our customers, a lot of value. We can deliver our product quickly, give them the confidence on our security, the best density. And we are -- and so we are very confident that we can create a lot of value to our customers. That's where we're concentrated. Operator: Our next question is coming from the line of Dylan Nassano with Wolfe Research. Dylan Nassano: Just want to go back to the Q4 kind of underperformance versus the guide. I know that in the previous quarter, manufacturing delays kind of came up, but it sounded like maybe those were resolved and you were operating on schedule again. So I just want to check what kind of changed between the last call and now? And like are these incremental kind of problems that popped up? And anything you can give us just to kind of boost confidence going into the quarter that these are kind of resolved at this point? Julian Jose Marquez: So we have -- thanks, Dylan, and clearly, we're disappointed with what happened. I mean, first thing, but I don't want to say sound apologetic in what I'm telling you. But -- so what do we have? We have our suppliers in the U.S., many, but I say the 3 main suppliers. Out of the 3 main suppliers, 2 are doing great. I would say even more, the 2 that have the more complex process are doing very well. So we're very happy, ahead of schedule, doing wonderful, no problem. We have a less complex process, which is enclosure manufacturing. When we met last quarter, we had a plan that was going to be able -- going to allow the delivery of our revenue for the year, but that it required a major staffing process that I think we underestimated the ability to staff that facility. I think that today, that we have done 2 things. We have clearly gone out and continue staffing and preparing people, and we're essentially done in terms of staffing. There's still some people, but it is essentially done. And we have made some changes in the way we are with our contract manufacturer to ensure that we meet our -- that we need to facilitate the manufacturing process. That's the right word. And I think the two combinations, having staffed the place, and we're talking about a significant number of people. This is roughly 500, 600 people that we needed for that facility to work with 3 shifts and all of that. We were fully -- essentially fully staffed. And with the changes in operations, we are meeting our numbers. I think we are -- we expect to do -- we were doing at the end of last quarter, 1.5 closures per day. We are already at 5, and we are ramping up, and I don't know that we will be able to meet our numbers very well. So we are very confident today. Unfortunately, we did not meet what we could not deliver on the revenue, and we are disappointed, but we learned very quickly. Our operation and manufacturing team is very, very good and they have put in place their corrective measures to this. Ahmed Pasha: Yes. Dylan, the only thing I would add is I think that from our perspective, as Julian said, yes, because of the labor shortage, we were roughly 1.5 containers per day. Fast forward, we added 500 people. We are now running at 5 containers per day and which is in line with our expectations for the quarter. So we feel pretty good where we are. But equally importantly, I think we pulled our levers to deliver on our profitability commitments. As you saw, the margin and the EBITDA, we are in line with our top end of our range. Dylan Nassano: Got it. I appreciate that. And then my follow-up, I just wanted to check on this new cell supplier. Can you just give us any more color around how much incremental capacity this may get you? Any -- are you prepaying for any sales like similar to what you did with AESC? And yes, so mostly just curious like does this get you net additional capacity to serve the U.S. market? Ahmed Pasha: Yes, I can take that question. Dylan, yes, I think this gives us enough capacity to serve our projected loads for the next couple of years. So we feel pretty good what we have signed. And in terms of the deposits, no, no material deposit commitments. I think it's just as we get the deliveries, we make those payments. Operator: Our next question coming from the line of Ameet Thakkar with BMO Capital Markets. Ameet Thakkar: I just wanted to kind of go back to kind of the implied EBITDA margin for this year versus last year. I mean it looks like the EBITDA margin is down, and I know the gross margin is also kind of down sequentially. But it looks like the implied ASPs in your bookings are actually up pretty significantly kind of quarter-over-quarter. I was just wondering if you could kind of walk us through why, I guess, the gross margin is lower year-over-year versus kind of the rolling 12 months. Ahmed Pasha: So I think the ASPs, your question is, yes, I think is down, but no surprise. I think ASPs are down roughly, I think, give or take, 10% or so. In terms of the gross margin, I think we basically are pretty much in line. I think the EBITDA margin as you ask, is obviously, there's an operating leverage because volume was less. Last year, our overall revenue was $2.7 billion. This is $2.3 billion. So yes, I think -- but the more important thing, frankly, from our perspective is as we grow the top line, we will benefit from the operating leverage and our goal is to continue to grow EBITDA. Obviously, that is what the shareholders care. At the end of the day, top line is great, but at the end of the day, that should translate into the bottom line. And that's what we, as a management team also are on the same page. So stay tuned. I think our goal is to continue to improve the top line and also the bottom line. Ameet Thakkar: And then I know you kind of talked about a couple of kind of uses of liquidity for next year. But just in terms of kind of like the kind of the free cash flow expectations relative to that $50 million kind of EBITDA guidance at the midpoint. Any kind of, I guess, guidepost there, please? Ahmed Pasha: So yes, I think the $50 million EBITDA, I talked about the working capital, roughly $100 million as our revenue is growing by from $2.3 billion to $3.4 billion. So $1 billion or so of additional -- as if you recall, we said in the past, working capital needs are roughly 10% of our growth in revenue. So about $100 million of working capital needs and then $100 million of investments in the domestic content, as I mentioned in my remarks. Beyond that, we don't have any material commitments. So I think next year, our goal is to be free cash flow positive as our revenue grows and our EBITDA grows. So I think that is the goal. But this year, $50 million is the EBITDA, but then we have working capital needs of $100 million. But I think more importantly or equally importantly is liquidity will remain very robust with this working capital use. So our goal is to continue to strengthen our balance sheet with growing cash and our credit facilities. So we feel pretty good where we're going to land at the end of the year. Operator: Our next question coming from the line of Julien Dumoulin-Smith with Jefferies. Julien Dumoulin-Smith: Nicely done this quarter. Just following up on a little bit about some of the margin commentary and just filtering that back in with AESC. Can you comment a little bit on how you think about margins being tethered to whatever happens with respect to your domestic supply, whether that's with AESC or incremental supply. Does that -- is that part of the commentary about margin improvement? And then related, can you just give a little bit more of a detailed update around AESC specifically? I know that you've sort of "procured a backup here, if you will. But how is that relationship evolving here? How would you frame out volumes from one side or the other side of that supply arrangement now at this point? Julian Jose Marquez: In terms of margins, in terms of AESC, I mean, any deal we do, we might do with AESC will be accretive. So that's the way you need to think about it. We -- when and if it happens, we'll communicate what it means in terms of margins. And I think that Ameet's point was more general. When you looked at our performance -- at least since I got here, we got a company with negative margins of 4%. We're now on a running average of 12 month average, we're now at 13.7%. So my point is we all here want to commit to continue showing a growing line. That's kind of what we're doing, and we're finding ways to do it today and continue to work on it. That was more of that coming in that direction. In terms of AESC, what I would say is that we are -- meeting the OB3, OBBA compliance is a complex process. We have been able to make a lot of progress. And generally, you can look at it from 3 areas. You need to meet the IP. And I think we have a solution that's done and we can -- the IP in that -- for that production facility meets the criteria of OBBBA3 -- OBBA or meet the criteria. Then we have the material systems, the need that the suppliers of the facility cannot come from PFP suppliers. We have a plan that will deliver that. And then we have the ownership. And the ownership is the one where we are still debating. We are making good progress. We're committed to resolve it, but we haven't -- have not reached a final deal. What we have always said, we're not the only option in town. So there are other ways that they can resolve this issue. And I don't want to -- we clearly believe that we are the best option from my point of view, but they can do something different. So -- and then on the new supplier, I mean, what it is, is we're generally diversified suppliers. That's a rule of life. So we're diversified suppliers. And the demand we see is very big. So we need to continue to meet the growing demand. So our philosophy of diversified suppliers and the growing demand call for the second supplier. So that's where we are. We are -- we see this as one of our competitive advantages. We are a first mover in this area, and we want to continue being the first mover. So that's the reason for our strategy. Julien Dumoulin-Smith: So just to clarify that real quickly, basically, your current plan and current margin expectations assume that you're served with AESC. And would it be improved or detrimental to shift the supply, if I heard you right or understand. Julian Jose Marquez: Yes. I mean I will say the following. The -- as I said, a potential deal with AESC will be accretive to the current numbers. That answer I can provide. Julien Dumoulin-Smith: All right. You're already here cutting it. Okay. Understood. Julian Jose Marquez: No, I'm not cutting that. Having done the deals yet. Julien Dumoulin-Smith: Okay. All right. Got it. No, that's why I asked. I appreciate it. Operator: Our next question coming from the line of David Arcaro with Morgan Stanley. David Arcaro: In terms of the data center pipeline, I was curious just to get your -- what you're currently seeing. Is this bringing larger project sizes versus your current backlog? Is it more U.S. heavy in terms of region where you're seeing that demand? And would be curious what kind of duration you might be exploring for those types of projects? Julian Jose Marquez: Yes. I'll say that generally, we talked during the call with one of the big drivers of the elasticity of demand where you can see the elasticity of demand for our technology as prices has come down has been how projects are getting bigger. And we have today 38 projects that are 1 gigawatt hour or more. I don't think that the data centers are bigger, naturally bigger, they are in line with what we have when you look at it, some are smaller, some are bigger, but generally in line. In terms of where geographically today, I will say the majority come from the U.S., and we have seen some -- the pipeline development in APAC and Europe is a little bit behind, but -- so that we see what we will see this as a global market. So that's kind of our view. In terms of duration, it depends on the use case, we see from 2 to long duration storage, both the whole -- nothing below 2, but that's where we are. David Arcaro: Okay. Got it. That's helpful. And then I was just curious about strong order intake in the quarter -- in this past quarter. I was wondering if you could talk to what the -- whether there's a common driver there that you're seeing. It doesn't seem to be data center growth just yet, if I'm interpreting that correctly. So what are you seeing in terms of what drove the strong rebound? Julian Jose Marquez: It was Australia the big driver of the strong quarter in '20, the strong order intake. We have these deals in Australia, as you know, that we were delayed in '25. We signed them all and they all -- most of them occur late in the year. So that's a big driver of it. But we see for '26, the U.S. being the big driver and a little bit of a change. And we'll see some -- I expect to see some data center stuff happening in '26 late in the year, most likely. Operator: Our next question coming from the line of Mark Strouse with JPMorgan. Mark W. Strouse: I just wanted to go back to the second domestic content supplier. Ahmed, I think you said that your needs are met for the next couple of years. But I just wanted to clarify, is that capacity available today? Or is there kind of a ramp period that we should be expecting? Ahmed Pasha: No. I think the capacity is available -- will be available in about next 10, 11 months. But I think the capacity that we need to serve our load, as we discussed during the call, we have about 85%, 90% of our revenue in our backlog, and we have already secured the capacity for that. So we don't need this capacity, but we are now locking in additional capacity to basically secure our future business. Mark W. Strouse: Okay. And then on the long duration side, is Smartstack the only go-to-market solution that you have there? Are you potentially looking to partner up maybe being a systems integrator for some of the more emerging technologies that are out there? Julian Jose Marquez: Smartstack will be our accelerator. What we're going to do, and we believe that very competitive. So it will be Smartstack. Operator: Our next question coming from the line of Christine Cho with Barclays. Christine Cho: With respect to the data centers, you mentioned the 3 different ways that you can serve data centers, the interconnection backup and power quality. Would you be able to sort of like break down the opportunity set here and maybe rank it? Like is half of the opportunity for power quality and backup is the smallest? And for duration, you mentioned 2 hours is the low end. I'm assuming that's for power quality. Is it similar for those who are interested in getting storage for interconnection purposes? Julian Jose Marquez: Yes. First point, that's what -- that I would like to highlight. So we have these 3 needs. What's wonderful about our technology and now talking about battery storage, not necessarily ourselves, is that we can stack up these 3 needs with the same technology solution. While the other technology solutions can do one or the other, but they cannot do what we do, which is facilitate interconnection, do backup power and do quality. And that makes the difference. And I think that's what makes our solution so attractive to our data centers. We can resolve 3 problems with one technology. So that's very, very good. In terms of the 2 hours, these are -- depends on the need of the customer. So I cannot really put out -- can tell you this is what drives it. But generally, you're right on the view that backup power and interconnection flexibility will tend to be longer duration, while power quality will tend to be shorter duration. Generally that's true. But I think you need to think about this differently. Is the ability to serve the 3 needs with the same infrastructure. That's what we are aiming for because that's where I think that will make our technology, the preferred technology solution to resolve to address these problems. Christine Cho: Okay. And then if you are able to vertically integrate with AESC, how should we think about what the mix will be between the AESC supply and the second supplier? And with this second supplier, is a contract for a set amount of time? And then lastly, for your international projects, are you also diversifying your cell suppliers there? Julian Jose Marquez: We are -- we've always been diversified internationally. We're just being diversified locally. My view on this is that it is -- we convert any battery into a great technology solution. That's what we do as a company. So who the battery supplier is not as relevant. It shouldn't be as relevant. My customers shouldn't care and my financial investors shouldn't care. What I -- the real value we bring is the ability to make any battery great, no matter what. So that was my answer to it. I don't know what the mix will be. But as I said, for my customers, it will be irrelevant from a product delivery and capabilities, what batteries are produced. Christine Cho: But for you, doesn't it matter in that if you are using AESC and you're vertically integrated, it's higher margin for you versus... Julian Jose Marquez: I care about my customers. That's what I lose. Yes we will figure out that part. But the important thing is the ability to [indiscernible] the route to success in meeting your customer needs. That's what drives the company. But you're right, we might be able to get a capture -- if we were to be vertically integrated, there will be more margin on one or the other, but my real -- the way to win is meet the customer needs. That's the way to win. Not -- if you try to optimize something else, you get -- you lose the side. Your customer needs and that drives profitability, that drives margin, that drives everything. Operator: Our next question coming from the line of Justin Clare with ROTH Capital. Justin Clare: So I just wanted to follow up on the second source of the cell supply here. So I think you mentioned it will be available in the next 10 to 11 months. So just at the beginning of the year, do you expect to depend on the source of cells from AESC for domestic U.S. projects until that second source is available? And then so I'm just trying to get at how important is it for you to resolve the challenges with the FIAC restrictions by early calendar 2026 in terms of thinking through the outlook for the year? Julian Jose Marquez: Very, very important. That's what I will say. We have a plan, and we've been working on it, and it's very, very important to do it. So that's what I can tell you. I mean, we will get it done. Justin Clare: Okay. Got it. Good to hear. And then just a follow-up on the data center opportunity. I was wondering, are you seeing -- or could you talk about the ability to kind of successfully accelerate interconnection with storage being added to data centers? Is this being done today? Or do you need the regulatory framework to change in order to support this use case? And then wondering what the timing of orders associated with that use case might be? Julian Jose Marquez: We haven't signed any of these contracts yet. So this is a work in progress, but we believe we can -- we have the ability to ensure that the data centers meet the interconnection restrictions that they have. So I would say yes. I don't think you need a major regulatory change. It's just ensure that you meet whatever the grid is offering. Operator: Ladies and gentlemen, that's all the time we have for our Q&A session. I will now turn it back to Chris for any closing comments. John Shelton: Thanks, Olivia, and thanks to everyone for participating on today's call. We look forward to speaking with you again by first quarter results, if not before then. And please do -- looking forward to meeting with everyone as your questions arise. Operator: This concludes today's conference call. Thank you for your participation, and you may now disconnect.
[speaker 0]: Good afternoon, and welcome to the Petco Third Quarter twenty twenty five Earnings Conference Call. All participants will be in a listen only mode. After today's presentation, there will be an opportunity to ask questions. To ask a question, you may press star then one on your telephone keypad. To withdraw your question, please press star, then two. Please note, this event is being recorded. I would now like to turn the conference over to Tina Romani, Head of Investor and Treasury. Please go ahead. Good afternoon. [speaker 1]: And thank you for joining Petco's Third Quarter twenty twenty five Earnings Conference Call. In addition to the earnings release, there is a presentation available to download on our website at ir.pepco.com. On the call with me today are Jewel Anderson, Pepco's Chief Executive Officer Sabrina Simmons, PETCO's Chief Financial Officer. Before we begin, I'd like to remind everyone that on this call, we will make certain forward looking statements which are subject to a number of risks and uncertainties that could cause actual results to differ materially from such statements. These risks and uncertainties include those set out in our earnings materials and SEC filings. In addition, on today's call, we will refer to certain non GAAP financial measures. Reconciliations of these measures can be found in our earnings release, presentation and SEC filings. With that, let me turn it over to Joel. [speaker 0]: Thanks, Tina, and good afternoon, everyone. Thank you for joining us to discuss our third quarter results where I am pleased to share that we delivered another profitable quarter in line with our plan [speaker 2]: We've continued to strengthen the foundation of our operating model improve retail fundamentals, and position Petco for sustainable, profitable growth over the long term. We delivered sales in line with our outlook and meaningfully improved our profitability. Increasing operating income over the last year by over 25,000,000 generating 99,000,000 in adjusted EBITDA and more than 60,000,000 in free cash flow. I want to thank our teams across the organization for their dedication, focus, and execution on our transformation initiatives that are continuing to gain traction as reflected in our improvement in profitability and cash flow in Q3 and year to date. You've heard me talk about the importance of culture, and you will continue to hear that as a key theme of our transformation. When I joined Petco, we had a strong culture centered around pets first. The passion of our 30,000 partners was one of the many things that attracted me to joining. Over the last nine months, as a collective leadership team, we've been building on that culture in two ways. First, through reinstilling retail fundamental discipline which is driving increased financial rigor and accountability. This is a testament how the organization has embraced new ways of working with strengthened operating principles and was a large contributor to our results. Second, creating a culture that is playing to win. We are fostering a culture equally focused on operating discipline and a winning mindset. Last month, I had the opportunity to spend time with our support center and store leaders at our Leadership Summit. Together, we aligned on what our go forward values will be for a reimagined Petco, and what that means for our customers and our plans to execute on our One Petco Way vision. We are squarely in phase two of our transformation. Which is centered on improving profitability and strengthening our foundation from which to grow. The success to date has fundamentally changed the way we think and work to continuously identify future areas of opportunity that will further unlock long term value. At the same time, we are now strategically shifting resources towards phase three. A return to growth Now that our bottom line has meaningfully been improved, Last quarter, I outlined the four pillars that support Petco's return to growth. First, delivering compelling product and merchandise differentiation. Second, delivering a trusted store experience. Third, winning with integrated services at scale. And finally, serving our customer with a seamless omni experience. Let me now provide you more specific color on each pillar. Starting with compelling product, and merchandise differentiation. I view this in two categories. On the consumable side, we have improved shoppability. With higher in stock availability, Our customers rely on us to have everyday go to product. Better integrated assortment planning, and merchandising teams have been created improved in store experience as well as online. On the discretionary side, we are focused on infusing a steady stream of newness in 2026 that complements our evergreen product assortment with more seasonal, and trend driven buys. Previously, there has been a set it and forget it mentality. Which is not a very aspirational shopping experience, and one that we are changing. As we look forward, we see significant opportunity to change our collective merchandise mindset from solely a needs based business to also a wants based business by overhauling our product offering, and surprising our customers with unexpected ideas for their pets. A great example with the success of our online pilot our new My Human product line was expanded into over 200 stores This is a small milestone, but exemplifies our team's focus and ability to lean into trend forward impulse purchases. Next. Moving to a trusted store experience. Joe Venizia, our chief revenue officer, who joined us just about a year ago, leads our operations and services team. Since joining, he has been focused on store simplification, standardizing processes across our fleet, and taking costs out of our operations. He is now shifting his focus to additionally include revenue driving KPIs like increasing transaction size, driving sales contests, and increasing customer interactions. With our passionate partners, strong customer engagement, and a full suite of services, we can create both a fun and convenient experience that pet parents are unable to get anywhere else. Our store partners are a unique differentiator for Petco. We benefit from having long time passionate and knowledgeable partners that serve our pets and our pet parents. Our opportunity today is around making it easier to run our stores. Freeing up our store associates to interact with customers, and use what we call their superpowers of pet knowledge. Improving these areas will make it easier for us to drive sales growth in 2026. Moving now to services at scale. Our nationwide wholly owned and operated services business continues to be our fastest growing category. And is our competitive moat given its in person nature high barriers of entry, and difficulty to replicate. The holistic ecosystem between grooming, owned hospitals, clinics, and center of store can only be found at Petco. What especially excites me here is the opportunity we have with our existing assets. I think about it in three ways. One, improving utilization through increased staffing and appointment availability. Two, improving engagement. Through enhanced digital capabilities. And three, improving integration of services and center of store. With regards to veterinarian staffing, I'm pleased to share that we are ahead of our doctor hiring goals that we set at the start of the year with record high doctor retention. During the quarter, we also promoted two of our longtime leaders to chief veterinarians. Reinforcing our commitment to growing our veterinary business. Simultaneously are fostering a culture of team development, top talent recruitment, and execution of our strategic veterinary initiatives. All of this is foundational and is critical to increasing the utilization of our hospitals. Additionally, we are increasing access to care by strategically adding hours back on peak client demand and making appointments easier to book. You're standardizing processes across our fleet to secure in store follow-up bookings. We are increasing efficiency through our refined grooming apprenticeship model freeing up both appointment availability and increasing volume. And finally, we are enhancing online appointment scheduling to ensure we have better coverage and better flexibility for our customers. Clearly, Q3 has been a busy yet productive time for our services businesses. Let me spend a moment on improving integration between services and center of store. As the opportunity here may not be well understood. Historically, Petco stores and services were run relatively siloed which was a missed opportunity. There is a tremendous value unlock when better integrating our stores, and services experience. I'll give you a simple example. Previously, our veterinarians did not have access to customer purchase data. We are in the process of fixing that. And in 2026, our veterinarians will be able to see purchase history, and make more informed diet recommendations based on overall pet health, and specific needs. Taking that a step further, the veterinarian will be able to direct the customer to the recommended product in store or rec store associate to assist. This is a simple example, but illustrates how increased integration of services and stores create a better outcome for pets, and improved experiences for our customers. Now moving on to our fourth and final pillar, seamless omni integration. Layered on to everything I just discussed, are enhanced digital capabilities, more compelling membership offering, and a frictionless digital to store experience to customers wherever they choose to engage. I'm happy to report we are on plan with our improvements and in fact, we are starting to implement some of these changes in Q4 of this year. For example, we are transitioning the way we buy media, beginning with better targeting, and bidding strategies, which we expect to drive efficiencies in our marketing spend as we continue to strengthen Petco's reintroduction of our tagline where the pets go. I'm pleased with the progress on the membership program, and we will begin live testing and pilot the program this quarter in a small handful of districts. Our focus on these four pillars will fuel our growth which we still expect to see in 2026. In closing, as you can hear in my voice, this has been a productive quarter at Petco. And I'm pleased with the progress we continue to make on the commitments I outlined at the beginning of the As each quarter passes, we get better at celebrating amazing pet experiences executing our strategies, and delivering on our promises internally, and externally. The initiatives planned for the fourth quarter will advance the Petco transformation and I look forward to sharing updates with you in March. Ahead of the Thanksgiving holiday, I want to personally express my gratitude for our partners, who put pets first every day and boldly reflect who we are and what we stand for. Our Petco Love Foundation, has demonstrated our long standing commitment to saving lives finding loving homes for over 7,000,000 pets to improve the welfare of animals. With that, I'll hand the call over to Sabrina take you through the specifics of our third quarter results and outlook for the remainder of the year. Sabrina? [speaker 1]: Thank you, Joel. Good afternoon, everyone. In the third quarter, PEPCO once again delivered against our commitments while building a stronger foundation from which to grow. As we've discussed all year, strengthening the health of Pepco's economic model, has been our top priority. I'm pleased with our progress as demonstrated in our expanding gross margin, expense leverage, operating margin expansion. Not only in the quarter, but year to date. In line with our outlook, which reflects our decision to move away from unprofitable sales, Net sales were down 3.1% with comp sales down 2.2%. As a reminder, the difference between total sales and comp is driven by the 25 net store closures in 2024, and the additional nine net store closures year to date. We ended the quarter with thirteen eighty nine stores in The US. Gross margin expanded approximately 75 basis points to 38.9%. Similar to the first half, gross margin expansion was primarily driven by a more disciplined approach to average unit retail and average unit cost. Including stronger guardrails and more disciplined processes to effectively manage our pricing and promotional strategies. It's important to note that in this quarter, tariffs began to more meaningfully impact our cost of goods sold. Moving to SG and A. For the quarter, SG and A decreased $32,000,000 below last year and leveraged 97 basis points. As we've discussed previously, our shift in mindset and increase in rigor around expense management is evident in our results. Savings were achieved across the board in especially in g and a areas. Notably, marketing spend was about flat year over year. Our expanded gross margin and expense leverage resulted in operating margin expansion of over a 170 basis points Adjusted EBITDA increased 21% or $17,000,000 to 99,000,000 and adjusted EBITDA margin expanded nearly 140 basis points to 6.7% of sales. Moving to the balance sheet and cash flow. Q3 ending inventory was down 10.5% while achieving higher in stocks for our customers. We continue to manage inventory with discipline, which is one of the drivers of our improving cash profile. Free cash flow for the quarter was $61,000,000 and year to date was 71,000,000 Both the quarter and year to date were significant above the prior year. Notably, year to date cash flow from operations has nearly doubled versus the prior year to a 161,000,000. We ended the quarter with a cash balance of $237,000,000 and total liquidity of 733,000,000 including the availability on our undrawn revolver. And now turning to our outlook for the full year. We are once again raising our adjusted EBITDA outlook for 2025. We now expect adjusted EBITDA to be between $3.95 and $397,000,000. An increase of roughly 18% year over year at the midpoint. For the full year, given we are entering the last quarter, we are narrowing our range for net sales and now expect net sales to be down between two and a half percent and 2.8%. For the fourth quarter, we expect net sales to be down low single digits versus the prior year as we continue to execute on the initiatives we've outlined. We expect adjusted EBITDA to be between $93 and 95,000,000 It's important to note that the impact of tariffs is sequentially more meaningful in Q4. Additionally, the significant progress we've made year to date against strengthening our economic model and improving our earnings profile has provided us the option to begin selectively investing behind the business where it may make sense as part of our ongoing efforts to set the stage for phase three. A return to profitable sales growth. With regard to other guidance items, for the full year, we expect depreciation, to be about 200,000,000 net interest expense of approximately a 125,000,000 about 20 net store closures and 125,000,000 to 130,000,000 of capital expenditures with a greater focus on ROIC. In closing, as Joel discussed, we're in a period of significant change and I want to extend my deepest appreciation to all of our teams for embracing that change to deliver better outcomes for all of our stakeholders. With that, we welcome your questions. [speaker 0]: We will now begin the question and answer session. If you are using a speakerphone, please pick up your handset before pressing the keys. If at any time your question has been addressed and you would like to withdraw your question, please press star then 2. In the interest of time, please limit yourself to one question and one follow-up. We will now pause momentarily to assemble our roster. The first question will come from Simeon Gutman with Morgan Stanley. Please go ahead. [speaker 2]: Hi, guys. Hey, Joel. [speaker 3]: Let me I was intrigued by something you talked about. Some of the wants. Can you talk about can you frame what mix of the business is wants versus needs today? And it's maybe far out there. But what's the vision? And my guess is the wants aren't truly wants. I think it's you know, given your background, there's probably some unique merchandising that's partially wants, but curious how you can frame that and maybe tease it out a little. [speaker 2]: Yeah. Hey. Thanks, Simeon. It's a great question. And yeah, if you think about it in the traditional sense, you know, consumables is traditionally a needs business, and you know, is the overwhelming majority of our business. Even that business, Simeon, I think has some elements to it that can be more of a a wants in in principle. And and what I mean by that, and and I alluded to it in my prepared remarks, we've just had this, you know, set it and forget it mentality for our entire business. And if I just focus on consumables for a second, for example, in 2025, [speaker 1]: we [speaker 2]: our dog food business was largely all surrounded around one big episodic reset in the middle of the year. And we're really gonna change that in '25 And as as our big vendor partners come out with innovation, newness, different types of product, new flavors, cat extensions. We're we're gonna roll that out on on in line with their timing, not our timing. So that's gonna make more of a perception of wants rather than just needs in the sense that somebody walks in and and is a a sense of discovery. We just haven't been good at that in the past, Simeon. So think the whole business has an opportunity to create more of a exploration throughout our store, not just our supplies business, which is traditionally by the way you were thinking. There's an element to it in consumables as well. [speaker 0]: And certainly, when we get on the call in in March, we'll [speaker 2]: we'll go through that in more detail. I cut you off, Simeon. [speaker 3]: No. I cut you off. My my follow-up, it's related. You talked about integrating store functions. You talked about wants versus need. And then there was a little bit of maybe forward investing, I think Sabrina just mentioned. So if you and and by the way, the business itself is getting close to lapping like, whatever tough compares. It seems like it's naturally getting back to positive territory. So what what kinda clicks or what's the priority among the things we heard where the top line start to move, or is it something we haven't heard yet? [speaker 2]: No. I don't think it's something you heard. I I think look, we're gonna approach twenty twenty six from the top line the same way we approach 2025 from the bottom line. In 2024, we came out with the strategies that would fix the bottom line. And then we executed them in 2026. And 2025. We're doing the same thing for top line growth. I outlined four pillars, We backed it up with building blocks, which I talked about many of them today. And then we're gonna execute against those with the same rigor and discipline And so it it's not just to cross your fingers and hope. We've got plans around four pillars with a lot of building blocks for each one of them. And I'm I'm really excited about all four of them. I alluded to some of them that we're already testing here in Q4. But all of them are making traction, and some just take longer to implement than others. But teams are all focused, and we got a good plan. [speaker 3]: Okay. Happy happy Thanksgiving. Take care. Thanks, Simeon. Happy bet. [speaker 0]: Next question will come from Oliver Wintermantel with Evercore ISI. Please go ahead. [speaker 3]: Yeah. Thanks. Joel, what is the realistic [speaker 4]: timeline for comp stabilization? And which categories or customer behaviors would represent the biggest swing factors there? [speaker 2]: Yeah. Look. I'm not gonna get into 2026 today on this call and and the the timing of it. But certainly, what you should expect from me in March is to not only give you guidance for Q1, but we'll give you an outlook on on the full year. But, specifically, I can tell you, all four of the pillars I went through today are getting traction. And, know, so I would expect all four of them to contribute towards comp in in 2026. And then we'll just outline the timing for you on the March call. [speaker 4]: Got it. That makes sense. And then just on the free cash flow side, strong improvements there year to date and in the quarter. But how much of the Q3 working capital improvement is sustainable? What financial or operational levels continue to support the cash generation for next year? Yeah. I mean, I think [speaker 1]: we view cash flow and all of its levers as continuous improvement. We certainly are focused on continuing on the [speaker 5]: path of generate generating strong free cash. The principal lever, of course, Oliver, is net earnings. So we're gonna continue to focus on our bottom line and growing net earnings We'll continue to focus on inventory discipline, We're not done. We've made huge strides this year. and reducing In terms of rationalizing our SKUs our inventory compared to our sales, which is fantastic. But I wouldn't say we're best in class interns yet. We still have a lot of opportunity. We'll be looking at that lever as well as all of our other levers to continue delivering on strong cash generation. [speaker 4]: Excellent. Good luck, happy Thanksgiving. Thank you. [speaker 1]: Thank you. [speaker 0]: Question will come from Michael Lasser with UBS. Please go ahead. [speaker 2]: Can you size the magnitude of the potential investments that you would make and what forms those are gonna come in, whether it's [speaker 5]: labor [speaker 3]: marketing, [speaker 0]: or promotions, And are those [speaker 4]: investments [speaker 6]: necessary as you look to 2026 in order to drive top line growth? [speaker 5]: Well, maybe I'll just start, Michael, with the framework, and then Joel can chime in on how he feels. You know, he's looking at each one. What we've tried to do, and we're really pleased that we banked so much profit improvement through Q3. And this is afforded us as I said, the option and it's only an option to consider investing in areas that we think can drive improvements both in Q4, but also for our future. So everything you mentioned is on our plate of options. Certainly, marketing certainly looking at labor, And, sure, we'll always continue to look at promos to see if we can do them effectively. In a way that brings value to our customer. But also in a way that's very responsible as we continue to manage our margin expansion. [speaker 1]: Joel, do you wanna Yeah. I yeah. Sabrina, I think you [speaker 2]: you nailed that pretty good. And when Michael, I look at the four pillars we outlined, I don't think any of them as it relates to 2026 require any, you know, substantial step change from what we're doing today in terms of you know, cash investment or change in OpEx investment or something. It's it's really you know, you take merchandise. Like, we're selling through our existing merchandise, and we're buying into new. So that's really just a a steady flow change. And you know, really don't see any episodic change in in 2026. From an investment standpoint. From from the runway we're already on today. I I guess the question in the [speaker 6]: and and the critical point is Yeah. Can Petco experience the same magnitude of the improvement in the profitability while reversing what seems like some market share losses this year and beyond that path next year. [speaker 5]: Yeah. If I'm hearing you, Michael, and I and I might want you to repeat the question, but we, for sure, believe that investments are going to be necessary. Our whole focus and what I talked about all year long in terms of the economic model we're pursuing is delivering leverage. On expenses. But as you know, if sales improve, you increase operating expenses and still deliver leverage. So we're we're very aware that we need to make some investments That's why we're talking about in Q4 We may make some of those investments in advance. Of entering the new year because we've been able to bank so much profitability and leverage. And we will measure our success in meeting our goals and expanding margin and delivering expense leverage on a full year basis. That's another thing we always said. We never said every single quarter in the same way. It's on a full year basis. So that's why we've given ourselves the option because we know that the next phase will require investment we are prepared to stand behind that in a responsible way that still delivers on our full year goal to deliver the model. [speaker 6]: Hey, Sabrina. Could I could I just clarify? You know, if we look at what the embedded EBITDA margin is in the fourth quarter versus what Petco's experienced over the last couple of quarters. It looks like the pace of improvement is gonna moderate. Should we think about the magnitude of the potential investment, the option for investing would be the difference between what Petco has achieved over the last couple of quarters and what's implied in in the fourth quarter? Is that how we should think about quantifying that potential investment? [speaker 5]: I think that's a fair framework, Michael. I would add to that as we look to Q4, as I stated, remember, when we think about gross margin, there's more there's more tariff impact. That's just one factor. It's not enormous as we've said all year. It's it's we're pleased that we're in a retail sector that doesn't have mountains of tariff. It is an impact. So that's one factor. The second impact is that investment that we're talking about. And how much we will choose to do and how we'll manage through that in the fourth quarter. So, yes, I think your statement, broadly speaking, is fair. [speaker 6]: Okay. Thank you very much, and good luck with the holiday. [speaker 1]: Thank you. [speaker 0]: Next question will come from Kendall Toscano Bank of America Global Research. [speaker 4]: Please go ahead. [speaker 5]: Thanks for taking my question. Hopefully, you can hear me okay. [speaker 1]: I was just wondering if you could talk more about the impact of tariffs during the quarter I know you mentioned they became more meaningful in 3Q, but maybe not as much as you're expecting for the fourth quarter. But just curious what you saw in terms of COGS impact, if any? And then in maybe some categories where there was tariff impact on price? What did you see in terms of consumer elasticity? Thanks. [speaker 5]: Thanks. Yeah. Thanks, Kendall. Just to go back to our statement, So the first time we saw a tariff impact flow through our p and l, through cost of goods sold in any meaningful way is the third quarter. Because the second quarter had, like, let's call it, de minimis. Amounts of that. We had it on our balance sheet. We had it in inventory buys, but it wasn't flowing through COGS yet. The third quarter is the first quarter of that And my only point was in the fourth quarter, it becomes a bit more meaningful. So it's just a reminder that sequentially, the tariff headwind's a bit more meaningful. But, again, in the broad spectrum of things, it's a very manageable number, which we've managed all year and have been revising guidance upward in the face of it. So you know, I think that hopefully helps frame it up. We we also know that it's mostly in the private label supplies area. As we've said in the past. So, hopefully, that helps frame it up too. Got it. That's helpful. [speaker 1]: And then my other question was just in terms of some self inflicted headwinds in the services segment. As you've deprioritized that program ahead of the planned relaunch. Just curious as you're now getting closer to relaunching that in 2026, and it it sounds like maybe starting to pilot it in the fourth quarter What kind of tailwind would you expect to see on same store sales growth or I guess just service services growth? [speaker 5]: I I think you mean our membership program. That's Yes. That's what I meant. Yeah. That's what's combined with services in the way we report. Services and other. So I probably, Joel, if you wanna start with the membership program and [speaker 2]: Yeah. Because our our our paid membership rolls into there. But, you know, I think the more important thing to take away from that is and and I alluded to it in my prepared remarks that we are on track with our new membership program. And in fact, here in the fourth quarter, we have begun live end to end testing in several markets, and so, we really haven't seen any major glitches. In fact, minor at best. And so that's a really good sign for us. We'll then take that to a few more markets and and do, roll out the new attached to it. And are still on track then for a rollout sometime in 2026 with with the, the rest of the fleet. But membership so far has, really come together nicely. And it it's a really important element to our growth that's gonna begin in 2026. [speaker 5]: Yeah. And since you raised it, Kendall, on the services piece, I think you can see that that continues to be not only a strategically important area for us, but it's also an area of nice growth and continues to be. [speaker 2]: Thank you. [speaker 0]: Next question will come from Kate McShane with Goldman Sachs. Please go ahead. [speaker 1]: We wanted to ask, a little bit more of a higher level [speaker 5]: question, just your view on where you think the industry is now from a digestion standpoint, where you think the industry can grow, in in 2026 if if we do return to growth in '26 for the industry. And just what you may have been seeing out of the competitive set, [speaker 1]: this most recent quarter as, you know, some of these higher tariff costs and and prices have come through? [speaker 2]: Yeah. Thanks, Kate. Look. Overall, the the competitive set really hasn't changed much from the the last quarter. You know, I would say, you know, the what's changed is the consumer has been a little probably a little bit more cautious You know I mean? Obviously, with, you know, tariffs and political tensions and interest rates still high, you know, that's really been you know, bogging down their outlook on the economy a little bit. But as far as the pet industry goes, it it's been pretty stable. You know, flattish in terms of growth. I think the progress we've made on our digital side has really been promising, and and that'll be very important to us as we turn to growth next year. But overall, we're positioned nicely. Our services business is Sabrina just talked about, is already growing, and that is an area of growth in the pet industry. We'll and then we'll layer in you know, the focus we've made and the progress we've made on our our digital improvements. But overall, it's pretty stable. [speaker 5]: Yeah. [speaker 2]: Thanks, Kate. [speaker 0]: Question will come from Chris Bottiglieri with BNP Paribas. Please go ahead. [speaker 4]: Hey. Thanks for taking the question. [speaker 0]: Yeah. The first one I had was just hoping to now the cash [speaker 2]: free cash flow profile has improved. [speaker 6]: How do you think about prioritizing the usage of cash? Is it continued debt pay down? Do you think about reaccelerating the veterinary practices? [speaker 0]: Like, just curious how you think about that. Over the next few years. Yeah. Our first priority would always [speaker 5]: be to invest in our business. To sustain growth going forward. So that's definitely the priority. That said, we go back to our statement that we have a lot of assets on our book already. That really are ramping up now, vet hospitals predominantly the number one on the list, that are already on our books that we are ramping up for better returns. So we don't have to make big capital investments in those. And we, in fact, you'll hear us talk about more in the Q4 call, Chris, We have a set of those that where we're gonna focus on bringing utilization up 2026 as well, without any large capital investments. So I view this as really great news because it provides a nice path for return improvement while not having to invest a lot of capital in it. So, of course, though, we'll be looking at pockets and areas as we move forward, and we finalize what kind of remodel prototype we wanna land on. How we'll start to bring those into our system, But there's no huge big capital spend necessary in the horizon, likely to increase some in '26, but no big enormous dramatic change overall in profile because we have these assets in our books where we're increasing utilization. Now beyond that beyond that priority to first invest in our business, The second, of course, is we are always looking, as I stated, you know, on the first call when I talked to you guys, we want to bring down our leverage on an absolute basis. We also wanna bring down our ratio. We're doing a terrific job with the growth and profitability of bringing down the ratio. So it's quite remarkable. We started the year at over four times debt to EBITDA And if we hit the midpoint of our new guidance, we should be below three and a half times. Net debt to EBITDA. So quite a bit of progress indeed, we'll look to opportunities to even potentially do some opportunistic pay debt pay down. [speaker 4]: Gotcha. That that's really helpful. And then [speaker 0]: your gross margins were, I think, down 20 basis points on the product line. [speaker 6]: Is that primarily that tariff had been referring to? Or [speaker 3]: is it also somehow in is or is, like, is the [speaker 6]: elasticity offsetting the ticket increase, and there's also a headwind on comps? Just curious by [speaker 3]: like, [speaker 0]: tariff headwinds are you referring to there? Where it's manifesting? [speaker 5]: I have our merch margins expanded both in our products and services. [speaker 3]: Sorry. I meant quarter on quarter, not not year on year. [speaker 5]: Oh, quarter on quarter. Sure. Yeah. I would say that is primarily a little bit of tariff headwind coming in. Year on year, though, we are we are up in both products and services. [speaker 2]: Gotcha. [speaker 4]: Okay. [speaker 0]: Thank you. [speaker 1]: Next question will [speaker 0]: come from Steve Forbes with Guggenheim Securities. Please go ahead. [speaker 4]: Good afternoon, Joel, Sabrina. [speaker 0]: Joel, you you spoke about services in stores coming together. And and I guess my my question is is can you help us frame up [speaker 6]: sort of how you guys see that opportunity internally, whether it be how spending per customer sort of evolves as they engage in services, if they're a store only customer or vice versa? [speaker 4]: Like, any way that is sort of [speaker 0]: talk about how [speaker 6]: how, like, the net sales per customer evolves as they broaden their engagement across store? [speaker 2]: Yeah. Look. Look. I I think any you know, great bricks and mortar retailer has to define their moat, has to define what differentiates them from anybody else. And services is definitely one of our moats. Right? It's one of our key elements that, is really hard for any other pet retailer to replicate in the way we [speaker 4]: built out [speaker 2]: grooming, hospitals, vet clinics, dog dog walking, all or dog training. All those elements. And so that's obviously an area there for we've leaned in the most. And we've made incredible progress with our existing assets. You know, utilizations, we've improved. Engagement, we improved. And then what you're getting at is the integration with the center of store with product. And so what what's key to all that, Steve, is I look to 26. Is is layering that in with a membership program that really helps us better understand the profile of each one of our customers how many are using services, how many use services and merchandise, how many are buying, in store and online, and you put all those elements together, it starts to create profiles of different customers. And we we really see honestly, the better we get at services, the the halo effect that has on the overall business just gets stronger. Because it's something that's hard for anyone else to replicate. So service is probably the area that we made the most amount of progress. Pleased with the results we're seeing there. And, you'll continue to see us talk about that and but that gives you a little color on how I see it playing out. Turning into 2026. [speaker 6]: And then maybe if I just do a quick follow-up on that, like, there is there any way to set the baseline here on just sort of you know, what percentage of your customers today actually you know, buy services or or any sort of baseline KPI that we could sort of begin to track as we think about your progression in the business? [speaker 2]: Yeah. Look, I I I think at this point in time, I'm not gonna get into the the specifics on it at that level of detail. Mean, I think the the you know, baseline KPI to you know, track you know, as we we look into the future will be transactions overall. And and then let us manage it at the at the different elements we have, the serve up to the customer. But services will definitely be key component to it, Steve, as we keep growing. [speaker 6]: Thank you. [speaker 3]: Yep. You bet. [speaker 2]: Thank you. [speaker 0]: Last question will come from Zach Fadem with Wells Fargo. Please go ahead. [speaker 3]: Hi. Good afternoon. Is is there a way to quantify the impact of moving away from less profitable sales and and deemphasizing the member program in in Q3? As it seems like [speaker 6]: you expect your Q4 comp to step down a bit more, I [speaker 3]: I'm curious to what extent you're expecting those items to also impact Q4. [speaker 5]: Yeah. I mean, it's I'll I'll just start by it's it's a it's a pretty broad range. Zach, the implied Q4. So, you know, we can land anywhere in that range. Clearly, what we've stated all year very consistently is our primary focus this year was around expanding our margins walking those unprofitable sales and building this very strong foundation upon which to start sales growth. In 2026. But, Joel, I'll let you take it from there if you wanna Yeah. I I think [speaker 2]: Sabrina, I think you nailed it, and I I think I'd add to that. Like, you asked what's the impact? Well, the impact you're seeing quite clearly is you know, we're growing pet EBITDA market share. And so while sales are down, EBITDA is up. So clearly, we I I think we've done a really nice job of identifying which sales are really one time transactions and our empty calorie as I call them versus which customers we wanna grow lifetime value and and be with us for the long term. And so you've seen that play out quarter after quarter for us. As, you know, sales have been down, you know, consistently low single digits. But bottom line has continued to improve. So as each quarter goes by, we get better at identifying those largely or getting them out of our base. And you layer in a membership program. More strategic media buying, aspect, and all that'll start to lead towards improvement in the top line with the bottom line as well. [speaker 6]: Thanks, Joel. And then just to [speaker 3]: level set as we look ahead [speaker 6]: to to 2026. I mean, the expectation is to return to sales growth I'm curious how generally [speaker 3]: you would frame broader category performance in dog and cat food, supplies, services, etcetera. And then how you would layer in the the impact of both your initiatives and then net store opening and closings to kind of get to that [speaker 7]: total sales growth? [speaker 2]: Yeah. Look. I I think it's too early now to to spell that out specifically for 2026. I mean, clearly, if you [speaker 6]: look at what we've [speaker 2]: published, you can see the consumables and you know, supplies are are negative this year, and and we're getting growth in in services. We we expect to return to growth in in consumables and supplies going forward. What I've gotta just outline for you or translate for you is what I laid out today in terms of four pillars. How does that translate into growth at what time and what period next year? But lot what what you guys can't see is all the progress we're making here internally. And then we just gotta put the pieces together for you so you help you think about your model. But, you know, we haven't I think I answered on a few questions before. We're approaching 26. The same way we approach 25. Outline the strategies, and then execute. And, the the team is just getting better at that as every passing quarter goes by. [speaker 5]: Yeah. And, Zach, just to emphasize what Joel's saying, for sure, I think your thinking is in line with ours where you always look at what's you know, your base sales bill then we layer on all the many initiatives which Joel has been outlining. And we'll continue to get more granular as we go 26. But we have all of those building blocks on top of that base, and they layer on throughout the year. So what you can count on is it's a gradual ramp. And then the last thing I'll say as a little bit of a preview is we would expect fewer net closures in 2026 than we had in 2025. And, again, the 2025 expectation is about 20 net store closures. [speaker 7]: Thanks so much for the time. [speaker 2]: Thank Zach. [speaker 0]: This concludes our question and answer session. I would like turn the conference back over to Tina Romani for any closing remarks. [speaker 1]: Perfect. Thanks so much, Joel and Sabrina. Thanks, everyone, for your time. That concludes our call, and we hope everyone a wonderful holiday. [speaker 0]: The conference has now concluded. Thank you for attending today's presentation. You may now disconnect.
Operator: Good day, ladies and gentlemen, and welcome to the Urban Outfitters, Inc. 2026Q3 Conference Call. If you would like to ask a question during the presentation, please press star 11 on your telephone. You would then hear an automated message advising your hand is raised. To withdraw your question, please press star 11 again. I'd now like to turn the conference over to Oona McCullough, Executive Director, Investor Relations. Ma'am, you may begin. Oona McCullough: Good afternoon. And welcome to the Urban Outfitters, Inc. Third Quarter Fiscal 2026 Conference Call. Earlier this afternoon, the company issued a press release outlining the financial and operating results for the three and nine-month period ending October 31, 2025. The following discussions may include forward-looking statements. Please note that actual results may differ materially from those statements. Additional information concerning factors that could cause actual results to differ materially from projected results is contained in the company's filings with the Securities and Exchange Commission. For more detailed commentary on our quarterly performance, and the text of today's conference call, please refer to our Investor Relations website at www.urbn.com. I will now turn the call over to Dick Hayne. Dick Hayne: Thank you, Oona, and good afternoon, everyone. The Urban Outfitters, Inc. teams delivered another outstanding quarter. Total revenues grew by 12% and net income increased by 13%, both new third-quarter records. We are especially pleased to report that all brands produced positive comps across all geographies this quarter. This includes the powerful double-digit comps the Urban brand generated in both North America and Europe, and the exceptional growth in subscribers and revenue from the Nuuly brand. The agenda for today's call includes comments from Frank Conforti, our Co-President and COO, who will elaborate on Q3 performance by brand and business segment. After Frank, Tricia Smith, CEO of the Anthropologie Group, will speak to the performance of that brand and their newly launched Maeve concept. Melanie Marein-Efron, our CFO, will then walk you through our outlook for the fourth quarter, and I'll wrap things up with a few closing thoughts before we open the call for your questions. Frank, the floor is all yours. Frank Conforti: Thank you, Dick, and good afternoon, everyone. Today, I'm excited to share our company's third-quarter record results compared to last year, and then I will dive into some detailed notes by brand. Overall, our teams delivered another outstanding quarter, exceeding our plans and setting new sales and profit records. Total Urban Outfitters, Inc. sales grew by over 12%, reaching a Q3 record of $1.5 billion. All our Retail segment brands delivered positive retail segment comps, while four of our five brands posted record third-quarter sales, and Nuuly continued its impressive double-digit revenue growth. Our total Urban Outfitters, Inc. sales growth was partly driven by an 8% increase in the retail segment comp, with digital comps slightly exceeding store comps. Nuuly delivered strong 49% revenue growth driven primarily by an increase of 118,000 average active subscribers compared to the prior year. Additionally, the wholesale segment delivered an 8% increase in revenue driven by growth in the specialty store accounts, which was largely fueled by healthy increases in FP Movement. Next, I will turn your attention to gross profit. Urban Outfitters, Inc. saw a 13% increase in gross profit dollars, reaching a record $563 million. The gross profit rate improved nicely by 31 basis points, rising to 36.8%. Please note that this includes a $2 million impairment charge in the current quarter, which is worth 13 basis points. The improvement in gross margins was primarily driven by lower markdowns at the Urban Outfitters and Free People brands, as well as occupancy leverage driven by strong sales growth across all our brands. These gains more than offset lower initial product margins at all our brands due to increased tariffs versus the prior year. In the quarter, SG&A increased by 14%, deleveraging by 32 basis points. The growth in SG&A dollars was primarily driven by increased marketing spend, which fueled sales and customer growth for all brands. The marketing efforts drove increases in traffic and transactions, both in stores and online, for the total Urban Outfitters, Inc. retail segment. While Nuuly's campaigns resulted in healthy double-digit growth in average active subscribers. Overall, total Urban Outfitters, Inc. operating income rose by over 12% compared to last year, reaching $144 million, while the operating profit rate was consistent with the prior year. Net income saw a 13% increase to a new Q3 record of $116 million or $1.28 per diluted share. Now moving to brand performance, starting with the Free People brand. The team delivered a 9% increase in total revenue. Their sales growth was driven by a 9% increase in Retail segment sales, including a 4% retail segment comp, significant non-comp sales growth, and an 8% increase in wholesale segment revenues. The retail segment comp was driven by positive comps in both the store and digital channels, across all geographies, with an outperformance in accessory product sales. Non-comp sales grew by over 200% driven by new Free People and FP Movement store openings over the past twelve months. The brand is planning to open 43 new stores for the year, including 18 Free People, and 25 FP Movement stores. The brand is also encouraged by the strong results in Europe. While European operations are small relative to the total brand, new store openings continue to perform well, and the region drove a double-digit retail segment comp in the quarter, building on double-digit retail segment comps last year. I know Sheila Harrington and team are excited to capture more of the European market potential in the future. Within the Free People brand, the FP Movement business delivered strong total growth of 18% driven by a 4% Retail segment comp, strong Wholesale segment sales growth of 29%, and robust non-comp growth driven by new store openings. Continued strength in performance-related products is driving healthy new customer acquisition growth. The FP Movement brand saw increases in new, reactivated, and retained customers during the quarter. Based on our current plans, we believe the Free People retail segment could deliver a low to mid-single-digit positive comp in Q4. Free People wholesale revenues increased by 8% during the quarter, driven by sales gains in all geographies, while specialty store accounts led the way versus other accounts. As noted on our last call, as we move through the back half of the year, the wholesale segment faces more difficult year-on-year comparisons versus the prior year. Based on our current plans, we believe the Wholesale segment could deliver mid-single-digit comps in the fourth quarter. Now let's move on to the Urban Outfitters brand. Urban Outfitters recorded a strong 13% global retail segment comp for the third quarter. Congratulations to the team on delivering the first double-digit comp in some time. UO North America recorded a 10% retail segment comp and UO Europe an exceptional 17% retail segment comp. The total global comp was driven by strong store and digital comps with positive traffic in both channels and positive conversion in stores. In North America, the UO team continued their focus on their customer, and delivered a solid comp in both channels for the quarter, building on the strong start to the back-to-school season in Q2. In the third quarter, the business grew nicely across all major categories, anchored in strong regular price sales, new customer growth, and continued success in focused growth categories. Within women's, the denim business continued to be strong, complemented by pants, lounge, sweaters, and accessories. The brand is also encouraged by the progress in the men's apparel category, which delivered double-digit regular price comps in the month of October. In North America, from a marketing perspective, the team is focused on meeting customers in the moments and places that matter most. Whether that is across social channels, digitally, in our stores, or by hosting culturally relevant events. In the third quarter, the brand celebrated back to campus by hosting game day events at college campuses across the country, introducing and welcoming more customers into the brand. The brand also celebrated partnerships with some of Gen Z's most loved brands through On Rotation, a 360-degree brand spotlight, showcasing discovery, product engagement, and curated assortments. These engaging brand marketing events have been successful, driving an increase in unaided awareness and new customer growth. In Europe, the Urban Outfitters brand delivered an outstanding 17% retail segment comp driven by double-digit comp increases in both the store and digital channels. During the quarter, the business achieved positive double-digit comps across all major product categories. With these exceptional results, it is clear the European team is winning market share through amazing product execution, compelling marketing events, and strategies. Moving back to the Urban Outfitters brand globally, we are proud to note that the brand delivered low single-digit operating profit margin in the third quarter. This significant improvement was driven by a remarkable year-on-year profit increase in Europe, followed by a meaningful reduction in operating loss in North America. Based on our current plans, we believe the global Urban Outfitters brand could deliver a high single-digit positive retail segment comp for the fourth quarter. Now turning to the Nuuly brand, which delivered another exceptional quarter. Total Q3 revenue grew by 49%. The impressive growth was primarily driven by an increase of over 40% in average active subscribers, reaching just shy of 400,000 average active subs versus the prior comparable quarter. Nuuly's growth added 3.5 percentage points of revenue growth to total Urban Outfitters, Inc. sales. Our primary focus remains on scaling the Nuuly business and building brand awareness, which we are doing through investments in logistics and strategic marketing. We are pleased to report that our planned logistics expansion in Kansas City, Missouri, including increased storage capacity, and the implementation of new sortation automation, remains on track. Our latest marketing campaign was successful in driving new customers and continues the positive momentum of the brand. Overall, Nuuly's continued strong performance highlights the large growing opportunity for apparel rental in the US, and we believe we are making the appropriate investments to enable Nuuly to continue winning market share. Based on our current plans, we believe Nuuly could deliver healthy double-digit revenue growth in the fourth quarter. Now moving on to tariffs. The macro landscape remains consistent with what we discussed on our last call. We estimate that tariffs negatively impacted our third-quarter gross margin rate by approximately 60 basis points, and we currently believe will have an impact of approximately 75 basis points in the fourth quarter. Despite these headwinds, we still believe we can achieve approximately 100 basis points of gross margin improvement for the full fiscal year 2026. Our teams continue to work diligently on tariff mitigation efforts, including negotiating vendor terms, modifying our countries of origin, adjusting transportation modes, and strategically managing pricing. I want to emphasize that this plan reflects our current knowledge, and there is still a lot of uncertainty in today's environment. This uncertainty, in addition to our ongoing mitigation efforts, makes it challenging to predict the impact of tariffs beyond the fourth quarter. In summary, it was an exceptional quarter. All brands delivered positive retail segment sales comps, wholesale produced healthy revenue gains, and the subscription segment drove double-digit revenue growth. We believe we are on track to deliver record sales and operating profit for the year, including approximately 100 basis points of growth and operating profit margin improvement despite tariff headwinds. We could not be prouder of the teams and their amazing execution. On that note, I will now turn the call over to Tricia Smith, Global CEO of The Anthropologie Group. Tricia Smith: Thank you, Frank, and good afternoon, everyone. In the third quarter, the Anthropologie Group delivered an 8% retail segment comparable sales increase, driving 8% growth in total brand revenue. This achievement marks the nineteenth consecutive quarter of positive comparable sales for the Anthropologie Group. Importantly, we were able to maintain strong double-digit profit rates through improved gross profit margins despite ongoing tariff headwinds. The Retail segment's comparable sales growth was robust, driven by strong comps in both digital and stores across all regions. Category strength remained consistent across apparel, accessories, and weddings, complemented by an acceleration in sales trends within the home category. Turning specifically to apparel, our strength continues to be driven by the brand's multiyear focus on modernizing the assortment and elevating our own brands. These offerings remain our customers' most coveted selections and continue to drive substantial growth. This success is tangible. Own brand penetration achieved a historical high, increasing by over 100 basis points versus last year. We're strategically investing in these unique brands, including Maeve, Celandine, Lyrebird, and Pilcro, which are supported by a strong design team and a distinctive creative point of view. We believe this customer affinity for our own brands positions them for continued growth opportunities. Highlighting the power of our own brands, this quarter saw the launch of Maeve as a stand-alone brand, transitioning it from a beloved in-house label to a dedicated boutique concept. Our first Maeve Boutique opened in Raleigh, North Carolina, and the results have exceeded our expectations with a high double-digit beat of our forecast. This launch has proven accretive to our business in the Raleigh-Durham area, driving increases in total store sales across the region, inclusive of existing Anthropologie stores. Furthermore, digital demand for both Maeve and Anthropologie in the trade area has outpaced brand-wide demand growth since the store opening. Building on this success, our next Maeve boutique is scheduled to open at The Shops at Buckhead in Atlanta, with an additional location to be announced in 2027. Moving now to the Home business, where we saw an acceleration in sales trends during the quarter. Anthropologie Home achieved high single-digit comparable sales, which was in line with total brand comparable sales, driven largely by the strength of our full-price business. Growth was concentrated in home accessories and textiles, and notably, regular price furniture sales turned positive during the quarter. Home accessories, a key point of entry for new customers, delivered double-digit comps and double-digit new customer growth. We're excited about the current trajectory and growth potential of our home business. Our brand-wide growth continues to be fueled by strong positive comparable sales across both digital and retail channels. In our digital channel, we drove double-digit session growth while holding conversion flat. We are continuously investing in our customer digital experience to reduce friction in the online purchase process and drive conversion. In our stores, the focus on service and experience is yielding results. Our in-store styling services grew double digits this quarter, and the high-touch appointment-driven Anthro Weddings business significantly outpaced total brand comp. These strong channel performances validate our strategic investments in both our physical store footprint and our digital capabilities. Building on the success in stores, we're executing a robust plan for new Anthropologie stores in addition to the Maeve boutique launches. Year to date, in FY 2026, we have opened eight new stores in North America and plan to open an additional three before the end of the fiscal year. Internationally, we also have three new stores opening in the UK, with Liverpool and Glasgow opening earlier this month and Manchester opening later this week. Importantly, our new Anthropologie stores are not only exceeding our expectations but are also driving outsized digital demand in their local markets. By the end of fiscal 2026, we will have 250 Anthropologie Group stores globally. Underpinning our growth strategy is exceptional marketing that drives customer acquisition and retention. Our messaging this quarter was anchored by two high-impact campaigns: our 1,000,000,000 impressions and our Anthro Always Fall campaign, a cinematic cross-category story. This approach successfully balances data-led discipline with emotionally resonant storytelling that speaks to new and existing customers. As a result, our total customer count grew high single digits this quarter, and over 30% of new customers have returned to make a second purchase, with our own brands driving the majority of this new customer growth. Looking ahead, we're expecting mid-single-digit comps for Q4. We are committed to our strategy and focused on our North Star of product modernization, customer growth, and leveraging creative, as we enhance our selling environments with exceptional experiences for our customers. I would like to take this moment to thank our incredible teams and global partners. The thoughtful, customer-obsessed way in which you work continues to delight our customers and supports the growth of our business. With that, I will now hand the call over to Melanie Marein-Efron. Melanie Marein-Efron: Thanks, Tricia, and good afternoon, everyone. Let me walk you through how we're thinking about our fourth-quarter financial performance. Based in part on our start of the quarter, we are planning for total company sales to grow in the high single digits for the quarter. In our Retail segment, comp sales could grow mid-single-digit positive, with high single-digit positive retail segment comps at the Urban Outfitters brand, mid-single-digit positive retail segment comps at Anthropologie, and low to mid-single-digit positive retail segment comps at Free People. And Nuuly, the brand could deliver mid-double-digit revenue growth driven by continued subscriber momentum. Finally, our Wholesale segment could produce mid-single-digit growth. Based on our current sales performance and plan, we believe Urban Outfitters, Inc.'s full-year gross profit margins could increase by approximately 100 basis points, with the second half growing by approximately 50 basis points versus last year. Within the remaining second half, fourth-quarter gross profit margins could increase by approximately 25 to 50 basis points as lower product markdowns, particularly at the Urban Outfitters brand, are partially offset by lower initial merchandise margins due to increased tariffs. Our current assumptions on tariffs are based on the announced tariff rates as of November 24, which includes a 50% tariff rate on goods from India. Turning to SG&A, we expect expenses to grow roughly in line with sales for the full year and fourth quarter based on current sales performance and plans. The planned growth in fourth-quarter SG&A is mainly driven by higher marketing spend to support customer and sales growth, along with increased store labor costs related to new store locations. As always, if sales performance fluctuates, we maintain a certain level of variable SG&A spending that we can adjust up and down depending on how our business is performing. We are currently planning for an effective tax rate of about 23.5% for the fourth quarter and 22.5% for the full year. Now on to inventory. In Q4, we expect inventory could grow at a rate similar to fourth-quarter sales as our teams continue to focus on increasing our product turns. For FY 2026, capital expenditures are planned at approximately $300 million. The FY 2026 capital project spend is broken down as follows: Approximately 45% is related to retail store expansion and support, approximately 35% is related to supporting technology and logistics investments, and the remaining 20% is for home office expansion to support our growing businesses. Lastly, we're planning to open approximately 69 new stores and close approximately 17 this year. Most of our net new store growth will come from the FP Movement, Free People, and Anthropologie. Specifically, we're planning 25 new FP Movement stores, 18 new Free People stores, and 16 new Anthropologie stores. As a reminder, the foregoing does not constitute a forecast but is simply a reflection of our current views. The company disclaims any obligation to update forward-looking statements. With that, I'll hand it back over to Dick. Dick Hayne: Thanks, Melanie. As you've heard, our teams produced another great performance, with every brand contributing meaningfully to our outstanding results. Robust comparable sales across our brand portfolio demonstrated their power and the rigor of our execution. The Anthropologie, Free People, and FP Movement brands achieved record sales while successfully maintaining double-digit operating profitability. The Urban Outfitters brand posted strong double-digit comparable sales in both geographies, driven by better product, improved marketing, and more full-price customers. As a result, the Urban brand delivered significant profit improvement versus last year. Complementing their retail results, Nuuly, our subscription rental concept, continued its impressive trajectory of strong subscriber and revenue growth while delivering healthy operating profit. During the quarter, customer engagement was lively, with both store traffic and online session growth up sharply. Our customers responded enthusiastically to our compelling product offerings and distinctive brand experiences, driving record third-quarter results. This sustained performance is a direct testament to the strength and resilience of our diversified business model. We have built a strategic model that is sturdy across multiple dimensions. Our diversification by channel, spanning stores, digital, wholesale, and subscription services, and by brand, with a portfolio catering to different customer segments, provides inherent stability. Furthermore, our broad category offering, apparel, accessories, shoes, home, and beauty, ensures that as customer preferences shift, we will remain relevant. This powerful multifaceted approach to diversification gives us high confidence that with smart execution, we can continue to grow our market share regardless of the operating environment. Looking ahead, November traffic and sales remain robust. Our retail segment comp sales are currently running slightly ahead of our stated Q4 plan to deliver mid-single-digit comp growth. We anticipate the holiday season will, as always, be highly competitive and promotional. We have observed a slight shift in consumers' behavior. We believe customers were waiting a bit longer this year to make their purchases until seasonal promotions began. And we successfully met this shift with strong results in our early holiday event. As Frank noted earlier, despite the expected promotional landscape, we believe the power of our model allows us to achieve improved operating margins in Q4 versus the prior year. For now, we are focused on closing the year successfully by delivering another quarter and year of record-setting results and continuing to deliver shareholder value. Finally, my thanks to our entire Urban Outfitters, Inc. family, brands, and Shared Services, for producing another superior quarter. I want to acknowledge the phenomenal job each of our brand leaders, their teams, and our co-presidents, Meg and Frank, have done. I understand the hard work and long hours you all devote to making our brands amongst the best in retail today, and I'm deeply appreciative. Our results are a testament to your effort and your talent. I also thank our partners around the globe for your cooperation as we work together to solve the problems imposed by tariffs. And finally, I thank our shareholders for your ongoing rich support. That concludes our prepared remarks. I now invite your questions. Operator: Then wait for your name to be announced. To withdraw your question, please press 11 again. We ask that you limit yourself to one question only. Our first question comes from the line of Lorraine Hutchinson with Bank of America. Your line is open. Lorraine Hutchinson: Thank you. Good afternoon. I wanted to follow up on the commentary around pricing. I think the words you used last quarter were gently and sparingly. And I wanted to see, a, how much of a customer reaction you've been able to realize from these price increases, and, b, if the expectation was that you would continue to protect opening price points, especially at the Urban brand. Dick Hayne: Hi, Lorraine. I'm gonna ask Tricia to take that question. Tricia Smith: Hi, Lorraine. We are being highly strategic and thoughtful about taking price, and these are definitely not across-the-board price increases. We've taken small price increases where we felt the price-value equation was appropriate and have seen really little to no price resistance where we did so. We also want to stress that we remain committed to maintaining our opening price points and our pricing architecture and protecting those items that our customers count on to have great price value. Next, we're really seeing very little incremental price increases over and above what we've already implemented this fall and holiday. We really don't anticipate price resistance. Our focus remains on protecting the integrity and the value of our product while we manage our cost structure appropriately. Dick Hayne: Yes. And, Lorraine, I want to emphasize that all the brands are protecting their opening price points. And furthermore, as we think ahead, we think that most of the price increases are behind us and that we'll have little need to raise prices next year. Operator: Thank you. Our next question comes from the line of Adrienne Yih with Barclays. Your line is open. Adrienne Yih: Great. Thank you so much. And I have to say, I mean, congratulations. Every aspect, every geo, every brand, it's pretty amazing. So congrats to everybody. Dick Hayne: Thanks, Adrienne. Adrienne Yih: You're very welcome. So, Tricia, just on kind of you talked about the own brand penetration. Can you talk about kind of where you are in the journey of own brand, where it could go, and what the global footprint for Anthropologie may look like, Europe versus North America? And then for Frank or Melanie, just on UO, so we have a, I think you said a positive low single-digit segment margin in the quarter. Where does that bring us year to date? And I think earlier, you had said that you didn't think that this year, you could break that profit barrier, right, to become, you know, positive. So, I mean, there's so much opportunity after this. So just a little color on kind of how you think about that for the year. Thank you. Tricia Smith: Hi, Adrienne. Our own brand growth, as I had mentioned in our opening remarks, has really been a source of strength for us as a brand. We're really leveraging the talent and strength of our design teams, our buying team. As I've mentioned, the penetration grew by almost 100 basis points versus last year. And we continue to plan and execute against our own brand growth outpacing that of just our total. We have successfully launched Celandine, Lyrebird, leveraging Daily Practice, and then really proud of the results the team's delivered with our Maeve expansion as a standalone brand and our concept store. So continued growth, we believe it will continue to outpace the total of our brand and expecting that to continue. I would say from a global footprint for our brand, really proud of the team successfully opening two stores in the UK. And the past several weeks and excited about the Manchester opening that will be opening at the end of this week. So we're in a place where I think we'll continue, as we mentioned, to open stores in North America. We'll continue to gauge the results of the stores that we're opening abroad in the UK and see an opportunity for us to continue to do so. I also think it's worth mentioning Pilcro. Yeah. That's definitely Pilcro. Really good season with Pilcro. Yeah. Pilcro's been a brand that has expanded significantly, and I would say several years ago, from a penetration standpoint in denim, and that's grown significantly now as our number one performing denim lifestyle brand for Anthropologie has been significant. Frank Conforti: And this is Frank, Adrienne. Thanks for your question. I just wanted to give an update on Urban. So first and foremost, I just want to say it again. Honestly, a huge congratulations to the entire team on the turn and the overall results. It's just, it's really great to see the progress the teams are making. Delivering such strong sales growth and great profit improvement. Yeah. As you noted, the brand was profitable on a global basis in the third quarter. This was driven by exceptional profit growth in Europe and a healthy reduction in the loss in North America. We're not ready to give a forecast exactly what next year could look like. Our business in Europe is already profitable and certainly was boosted by the extraordinary comp results so far this year. And while North America has delivered a meaningful reduction to their losses, they still have a healthy opportunity to continue progress into next year. And I would say given the size of the opportunity in North America, it is possible that the brand turns to globally to be profitable year on an annual basis, but we'd like to see exactly where this year lands before we commit to exactly what next year will look like. Operator: Thank you. Please stand by for our next question. Our next question comes from the line of Matthew Boss with JPMorgan. Your line is open. Matthew Boss: Thanks and congrats on another nice quarter. Dick Hayne: Thanks, Matthew. Matthew Boss: So, Dick, could you speak to drivers of the further acceleration in business you saw during the third quarter, notably at the Urban brand? Maybe elaborate on early holiday selling trends that you mentioned? Just how you see the setup for your brands through holiday? And Frank, so with 100 basis points of operating margin expansion anticipated this year for the company, how best to think about margin drivers or levers beyond this year if we think multiyear? Dick Hayne: Okay. Matthew, the drivers of the business across all the brands were the traffic. And traffic in stores and traffic online. And sales were almost exactly congruent with the increase in traffic. So I think that that's what did it. As we look into holiday, we think that the same thing is occurring. And we believe that the holiday season is likely to be very nice from a sales perspective. But we do expect it to be slightly more promotional than we saw last year. Let's say our customers aren't responding well to the new fashion. They are. And they are particularly responding to their gift-giving favorites. But they're waiting more patiently for anticipated promotions. And the events we've run so far have been very successful promotional events. So judging by the strength of those and the strong back-to-school season, and the surge in customer spending on holiday decorations, I anticipate a very good holiday season. Frank Conforti: And then, Matt, I can touch on operating profit. So, you know, obviously, we're extremely proud of what we produced last year delivering 100 points of improvement, getting to 8.6%. And, based on our current plans, we can deliver approximately 100 points of improvement in fiscal 2026, which would certainly put us very close to our 10% goal. As it relates to next year, I would just say it's a little early for us to commit to a rate. Obviously, as Melanie said, or as we target as a company, we're certainly going to target to keep SG&A at or below sales. But so then that leads to gross profit margins. And I just think there's a ton of uncertainty as to where tariffs are going to shake out given potential deals, Supreme Court rulings, our tariff mitigation efforts are ongoing. We'll have a better picture of this at the close of the year. But the one thing I do want to say is with all of that said around tariff impacts, if you were to ignore that for a minute, where our opportunities could land in gross profit would be driven by continued markdown improvement largely from the Urban Outfitters brand. We still think there's an opportunity to leverage store occupancy as, knock on wood, the brands continue to drive healthy comp sales. And, you know, when you're excluding tariffs, we actually still think there's IMU opportunity, which is great to see at all brands. Operator: Thank you. Please stand by for our next question. Next question comes from the line of Paul Lejuez with Citi. Your line is open. Paul Lejuez: Hey, thanks, guys. You mentioned pressure on IMU a couple of times, also lower markdowns. So just curious maybe you could talk a little bit about out-the-door merch margins. And what you saw by brand? And then second, on Nuuly, I'm curious if you've seen any change in the demographics in terms of age, income, regional, you know, of the new customers that you're attracting into that business versus what you've seen maybe several quarters ago? Thanks. Frank Conforti: Paul, this is Frank. I can take the sort of out-the-door, which was favorable given the markdown reductions for Urban Outfitters, Inc. As we noted, sort of all brands were impacted by the tariffs. And the lion's share of the markdown improvement was driven by Urban Outfitters, but Free People also had a favorable markdown rate in the quarter. And Anthropologie was just slightly up, but also did a really good job at offsetting their IMU and had gross profit gains overall as a brand for the quarter. So all three brands contributed to the within the retail segment to the gross profit gains for the quarter. And then Dave Hayne, I don't know if you want to touch on Nuuly? Dave Hayne: Yes, Paul. Thanks for the question on Nuuly. I would say that largely, we are seeing our customer base remain relatively stable in terms of the curve across age, you know, subscribers, demographic, geography. If anything, I would say we have seen a slight shift, ever so slight, towards a slightly younger subscriber in terms of our new customer acquisition, and we've seen a penetration from a subscriber standpoint, a slightly heavier penetration into the southern region of the country. More so than other geographies, mainly from a new customer standpoint. But those are just slight changes. There has not been a big transition or a big change in the composition of our subscribers. Operator: Thank you. Please stand by for our next question. Our next question comes from the line of Mark Altschwager with Baird. Your line is open. Mark Altschwager: Congrats on the strong results. Thank you. I wanted to follow up on gross margins. First, I guess, where was the upside versus your plan for the third quarter? Any surprises there? By brand or on the markdown front? And then just for Q4, you're commenting on expectations for higher promotions over holiday given the shift in behavior. But you are maintaining your guidance for the full year. So just curious what the offsets are there that are allowing you to hold that plan? Thank you. Frank Conforti: Sure, Mark. This is Frank. I can take that. I think the outperformance in the third quarter was largely just top line came in really healthy. So you got some better leverage, as it related to store occupancy, which was great to see with all brands contributing to that. As it relates to the fourth quarter, you hit the nail on the head. We are maintaining our annual plan and expectation to hopes of delivering approximately 100 basis points of gross profit margin improvement. I would like to say, I hope we're being conservative. But we do expect, as Dick noted, the holiday to be promotional. And, you know, if those promotional events are bigger than last year, that could have an impact on margins, and, you know, we're hoping that we're being conservative there. This does not mean, and I just want to be clear about this, that we're planning on more or deeper promotions because we're not. It just means over the past several years, we've seen this concept of highs being high and the highs being higher and the lows being lower as it relates to sales impact, sales events, I should say. So, again, I hope we're being conservative with the level of improvement we're planning, and we're really excited and pleased to hopefully be able to deliver that 100 points on an annual basis. Operator: Thank you. Please stand by for our next question. Next question comes from the line of Alex Straton with Morgan Stanley. Your line is open. Alex Straton: Thanks so much. Congrats on a great quarter. Maybe Frank or Melanie to start, I think you've put a 10% long-term margin target out there, but you'll be very close, if not there this year. So just curious how you think about that longer term and maybe what pushes you beyond it? And then while we have Tricia on the call, I just wanted to take a step back on Anthro. Feels like there's just been a structural change in the growth that that business delivers versus where it was at pre-pandemic. I'm just curious, like, what's changed? And how do you think about the durable growth rate for that business over time? Thanks so much. Frank Conforti: And thank you for the congratulations, Alex. This is Frank. So, as I said, we are still targeting 10% and knock on wood, we're hopeful we could get very, very close to that this year. Honestly, before we set a new goal, I'd like to hit the first goal. And, you know, as you know, I think everyone knows, there's still plenty of opportunity for us to drive improvement. You've got things like the UO turnaround, which is certainly in play right now. That brand, as we said, will still have a healthy opportunity to drive operating dollars and rate gains into next year. You've got Nuuly growing at a really healthy rate, and that gives us opportunity from a profit rate perspective as well. As I mentioned, you know, all the brands delivering positive comps, you've got store occupancy leverage and excluding what's going on with tariffs, which hopefully some of that changes in the future, I think all brands have IMU as well. So there's several levers out there that, you know, I think we can pull and hopefully deliver to exceed. But for right now, we're not setting a new target. I'd like to hit the first target first and hit that 10% and operate at it, and then we'll reset the goal. Tricia Smith: Hi, Alex. I'll speak to Anthropologie. Thank you for the question. You know, our team set out a little over four and a half years ago with really three strategic priorities, but really, I would say first and foremost, it was getting or delivering on our ability to drive full-price sales, which was really focused on newness. A lot of that came from really focusing in our own brands as I had mentioned. But I would say as we've worked on modernizing our product assortment, diversifying the categories that we're able to deliver, and ensuring that we have a broad-based appeal for the multigenerational customer base that we serve, has really been the bigger driver of that. You know, our customer base, as we focused on growth and acquisition, but also retaining our existing customers, has delivered over 50% increase in the last four years in our total customer count. And I think as we leverage that and think about how we execute and we deliver experiences both in stores and our teams have been very, very focused on ensuring that those experiences and the service delivers and exceeds our customer expectations, but also investing, I would say, in our digital capabilities, multiple factors contributing to our ability to be able to deliver improved conversion. And then I would say just lastly, making sure that we really deliver on those exceptional experiences and leverage our team's capabilities of design and creative and buying, we believe that we've really built a sustainable model for growth. Coming out of, I'd say, pre-pandemic that we've been able to deliver on and are proud of our team's ability to execute on those. Operator: Thank you. Please stand by for our next question. Our next question comes from the line of Dana Telsey with Telsey Advisory Group. Your line is open. Dana Telsey: Thank you. Good afternoon, everyone, and congratulations on the progress. As you think about the product, that's all I'm thinking about. As you think about, Dick, you mentioned it, some of them waiting closer for deals. Any framework for that? Is that across all brands, all demos, all regions? Or anything you're seeing in terms of the promotions that you need to drive? And then it was interesting on Nuuly with the continuing average active subscriber growth over, you know, 42% or whatever, it sounded like on the gross margin commentary, some of them are buying more of the rental product now. Are you seeing that shift? Is it from all ages, all income levels? And how does that impact the margin? Thank you. Dick Hayne: Thanks, Dana. The consumer pausing to wait for promotions, I guess I would chalk it up to intellect. I mean, they know that they know the promotions are coming. As I said to you, we saw a very rapid increase in mid to late October in people putting items in their carts, and that signaled us that this was the beginning of, okay, we know what we want. We know there are promotions coming, so why not wait? And if you think back maybe two or three years ago, when everybody was so worried about, oh, there's not, I guess it's because the transportation was difficult out of the Far East with COVID. And everybody thought, oh, there's not gonna be enough to go around, and people started buying earlier and earlier. I think what we're really seeing is just a reversion to what we saw before COVID. People did wait. And they did partake more in promotions. So I don't think there's any particular magic to it. I don't think it says much about the consumer other than they're smart. Dave, you wanna take the Nuuly? Dave Hayne: Yeah. Frank? Frank Conforti: Yeah. Sure. I'm happy to touch on it. Dana, you're absolutely correct. We did see a higher rate of sales to the customer in this quarter, and that has a lower gross profit than the subscription sales to the customer. There's a lot of ways in that we can sell product to the customer, sort of in the box through Marketplace through their direct website. We're not really seeing anything different from a demographic or major geography perspective as to where those things are coming from. And I think it'll just be variable from one quarter to the next. Operator: Thank you. Our next question comes from the line of Marni Shapiro with The Retail Tracker. Your line is open. Marni Shapiro: Hey, guys. Congrats to everybody. Thank you, Shay. But Shay. Oh my god. And that cardigan with the flowers, that is, like, rich thrift store vibes. So good. So my questions are for you. I hate baseball metaphors. And I understand Europe is on solid ground, but I guess where do you feel like UO is in this recovery process? And could we also just touch on men's? I feel like we glided right past. You had, you know, some sounds like some stabilization and slight improvement in men's. I'm curious if the men's business is a smaller part of Urban's business at this point given it's been a little tougher even than women's. And is it still putting pressure on margins, or is it neutral at this point? Shay Jensen: Hi, Marni. Thank you for the nice comments. You're talking about the Rachel Cardigan. It's one of our biggest and most beloved items, so I'm glad that you love it. Lots of customers do too. I'm really, really proud of that item. So, think your first question, where do we sit in the recovery? First, we recognize that this is a journey. We're incredibly proud of the team, and, you know, I think the team is executing really well on our plan. You know, they are staying acutely focused on the customer in Q3. Really, that was about occasions of getting back to campus. Game day was a big occasion and reentering campus life. From a product perspective, I think, you know, we continue to be, you know, excited about the categories that customers see us as a destination for. That would be denim and lounge and really anchored in our own brands, BDG and Out From Under. In marketing, the team continues to really delight customers, meeting them in places and moments that matter. Some exciting partnerships and activations in the third quarter, whether that was celebrating on rotation with UGG, which is our newest partnership and on rotation experience, or the partnership with Canva. Which was a really exciting proud moment. Our team, you know, drew insights with that 54% of young customers make wish lists for their holiday gift list. And so we partnered with Canva, and had three unique formats that our creative team developed. With 100 products and drop-down menus just from Urban Outfitters. That experience is live today with lots of customers participating in it. It's something that we're really excited about. And from a channel or touchpoint perspective, feeling excited about the progress that teams are making there. Seeing our creative really showing up in our stores, on our digital channels, across social, really evolved to be much more upbeat, really inclusive, and I think representing our product in a really, really delighting way. And we're excited to have opened two new stores representing our new store environment. I think we're hearing great things from our customers. Certainly, the environment is bright. I think more modern and from our perspective, allowing us to ebb and flow with categorical performance. And we're really excited about the early reads we're seeing from a productivity perspective from those two stores as well. Your next question on men's, we are really excited about what we're seeing in men's. You heard us mention that perhaps on the last call. Real proud of the men's team and the progress that they're making. This started with their focus on the customer as well, and they identified an opportunity to really broaden the assortment as they broaden the range of customers that they were serving to. For them, that really meant being more versatile. And focusing on young college guys. These are simple people. But we have an opportunity to really be more versatile. And focus on more outfitting and wardrobing for this customer. So the team had prioritized really redesigning and rebuilding our core items and anchoring in core categories that bottom pants, jeans, and sweats. Go figure, and some of their tops, so fleece programs and woven tops. And that is resonating really well. And so with some new customers in, the business, really proud to see that we are now a destination where they have more to buy from us than ever. Men's is an important part of our business, and I think that we really have an opportunity to differentiate in the marketplace. And be a destination, not just for our own branded product, but be a place where we can have some of the best national and discoverable brands for men. And that's something the team is working on as well. Dick Hayne: Marni, if I may, I'd like to say a word about Urban. As an ex-simple college guy who hasn't gotten much more complex as the years gone by. I want to give Sheila a big shout-out and also both team leaders, Shay in North America and Emma Wiston in Europe. They both delivered outstanding quarters. And her team produced the double-digit comp sales that you've heard about. Strong, very strong double-digit full-price sales. It shows that the turnaround strategy is working very well. In Europe, Emma and her team accomplished something I've really never seen in my many years in this business. They delivered a 17% comp sales gain with single-digit less comp inventory. And very strong positive double-digit full-price sales. So clearly, the momentum for both geographies is strong going into the holidays. And I just want to give my congratulations to all Global Urban brand employees. Operator: Thank you. Please stand by for our next question. Our next question comes from the line of Janet Kloppenburg with JJK Research Associates. Your line is open. Janet Kloppenburg: Hi, everybody. Can you hear me? Dick Hayne: Yes. We can. Janet Kloppenburg: I don't have to tell you how excited I am about such a strong quarter. I do want to talk to Shay about Urban. When I look at it, Shay, and I've called the company a long time, it looks like you are working to broaden the assortment and the customer that you're targeting. And I'm wondering if you could talk a little bit about that. And if your pricing strategy has changed and if what they're doing in Europe is similar to what you're doing here. Thank you. Shay Jensen: Hi. Hi. I'll take that first. This is Shay. Yeah. One of the first things that we did was a lot of customer research, and I think that we had identified that we had become unintentionally niche or narrow as it related to our product assortment. We had been focused on a bit of grungy, a bit of a narrow assortment. And I think we recognize an opportunity to be a bit more broad and welcoming in terms of our assortment and listening to our customers. They told us very clearly. We love your denim, and we love your lounge. And we love those two brands, BDG and Out From Under. But we weren't giving our customers enough of those brands and enough of those categories. So that is what we've been focusing on, and the customer has been responding. In like, a lot. And in sales. And, yeah, in sales. And we're gonna keep giving it to them as long as they keep responding. And, Janet, I'm gonna ask Sheila to talk about Europe. Sheila Harrington: Similarities with Europe. So I think the similarities of the consumer focus are very strong between Shay and Emma. Obviously, the customer is slightly different in what they want at any given time, knowing that Emma's touching on Europe, Germany, Netherlands, Spain, etcetera, and the countries that she's touching and just like similarities in North America or New York and the South respond differently to products. I think both leaderships are concentrating on their consumer, and that feels really, really good. There's great collaboration sharing a product between both countries to find the best results for the consumer. Proud of Emma's growth because it's not only just coming from the UK now. There's double-digit growth coming from multiple countries that she's continuing to build on. And will in the foreseeable future as our continued store growth happens in Europe. Operator: Thank you. Standby for our next question. Our next question comes from the line of Jay Sole with UBS. Your line is open. Jay Sole: Great. Thank you so much. I have two questions. First, I'm just curious about your wholesale business. As you look into next year, I'm curious about the kind of orders that you're getting from your wholesale partners given as they might have a different view of what 2026 might look like. Then there's some speculation today that Red Sea shipping lanes might open up. If that does happen, what might that how might that impact your margins next year? Shipping rates go back down to where they were? Thank you. Frank Conforti: Jay, I could take the Red Sea shipping lane. I would just say, you know, obviously, if that happens, the more lanes, the more opportunities, the better the opportunity is for us. But it's a little early for us to speculate exactly what rates are gonna look like and what the impact could be. But, yes, that would be a positive. You know, the supply and demand are good things, and a greater supply of transportation opportunities is a good thing for us. Sheila Harrington: And I'll take the wholesale question. It's an exciting time for wholesale because we're seeing the brand both Free People and FP Movement perform extraordinarily well within our wholesale account base. We do believe that as we continue to react and learn from our customer, from our deep CPG perspective, we have only the opportunity to continue to fuel our wholesale channel with the partners that we built. I think FP Movement had a spectacular quarter at wholesale this year, and we don't necessarily see that slowing down. We see our specialty store business thriving as we specialize our product into the outsourced space, our studio space, and the international opportunity we have with both brands. So we're really excited. Dick Hayne: I believe that finishes the call. I thank you all very much. I wish you a very, very happy Thanksgiving. I know you've got a lot of work to do. There was a backlog of companies reporting today, so I appreciate it. And we will talk to you soon. Operator: Ladies and gentlemen, that concludes today's conference call. Thank you for your participation. You may now disconnect.
Operator: Thank you for standing by, and welcome to Autodesk Third Quarter and Full Year Fiscal 2026 Earnings Conference. After the speaker presentation, there will be a question and answer session. To ask a question during the session, you will need to press star 11 on your telephone. To remove yourself from the queue, you may press star 11 again. I would now like to hand the call over to Simon Mays-Smith, Vice President, Investor Relations. Please go ahead. Simon Mays-Smith: Thanks, operator, and good afternoon. Thank you for joining our conference call to discuss Autodesk's fiscal third quarter results. Andrew Anagnost, our CEO, and Janesh Moorjani, our CFO, are on the line with me. During this call, we will make forward-looking statements including outlook and related assumptions and on products, go-to-market strategies, and trends. Actual events or results could differ materially. Please refer to our SEC filings, including our most recent Form 10-Q and the Form 8-K filed with today's press release, for important risks and other factors that may cause our actual results to differ from those in our forward-looking statements. Forward-looking statements made during the call are being made as of today. If this call is replayed or reviewed after today, the information presented during the call may not contain current or accurate information. Autodesk disclaims any obligation to update or revise any forward-looking statements. We will quote several numeric or growth changes during this call as we discuss our financial performance. Unless otherwise noted, each such reference represents a year-on-year comparison. All non-GAAP numbers referenced in today's call are reconciled in our press release and supplemental materials available on our Investor Relations website. And now I will turn the call over to Andrew. Andrew Anagnost: Thank you, Simon, and welcome everyone to the call. We delivered strong results today with revenue and non-GAAP earnings per share topping the higher end of our guidance ranges. Billings, non-GAAP operating margin, and free cash flow exceeded our expectations. We are again raising our full-year guidance across the board. As demonstrated at Autodesk University, shared during our recent Investor Day, and reflected in our results today, we are well-positioned to deliver for Autodesk customers and investors even in an uncertain geopolitical, macroeconomic, and technological environment. We are successfully executing on the most far-reaching transformations in enterprise software, redefining our business model, go-to-market, products, and platform. In doing so, we are making Autodesk more resilient and unlocking new avenues for growth and margin expansion. We're enhancing our products with cloud-based capabilities that seamlessly connect design and make workflows to deliver more value to our customers and expanding our addressable market opportunity. We're building a platform with a vibrant third-party ecosystem that will make our solutions more valuable, enable new monetization opportunities, and make Autodesk more efficient. And we're defining the AI revolution for our industries, empowering customers with new tasks, workflow, and systems automations, and capturing shared value subscription, consumption, and outcome-based business models that blend human and machine capabilities. Autodesk is building the future and the path to it. Our best days and greatest opportunities lie ahead. I've never been more confident in the long-term value we are creating for our customers, the industries that shape the world, and for you, our shareholders. I will now turn the call over to Janesh to discuss our quarterly financial performance and guidance. I'll then come back to update you on our strategic growth initiatives. Janesh Moorjani: Thanks, Andrew. Q3 was another strong quarter. Overall, the underlying momentum of the business was similar to prior quarters and better than the assumptions we had built into our guidance range. We again saw strength in AECO, where our customers are benefiting from sustained investment in data centers, infrastructure, and industrial buildings, which is more than offsetting softness in commercial. Upfront revenue, the Autodesk store, and billings linearity during the quarter were also stronger than expected. Our go-to-market optimization plan remains on track, and operational friction from the new transaction model implementation continues to ease. Total revenue in the third quarter grew 18% as reported and in constant currency. The contribution from the new transaction model to revenue was approximately $124 million in the third quarter. Total revenue grew 12% in constant currency and excluding the impact of the new transaction model. Please see the tables in our press release, earnings deck, and EXOR financials for details by product and region. Billings increased 21% as reported and 20% in constant currency. The contribution from the new transaction model to billings was $135 million in the third quarter. Billings grew 16% in constant currency and excluding the impact of the new transaction model. As a reminder, our billings growth this year is skewed by the new transaction model and by the transition to annual billings for most multiyear contracts. These tailwinds will significantly diminish next year. RPO of $7.4 billion and current RPO of $4.8 billion both grew 20%, benefiting from tailwinds from the new transaction model. Turning to margins, third-quarter GAAP and non-GAAP operating margins were 25% and 38%, respectively, reflecting year-over-year increases of approximately 330 and 120 basis points, respectively. This reflected operating leverage and ongoing cost discipline and was partly offset by the margin drag from the new transaction model. Our margin progress this year sets us up well to achieve the long-term margin goals we talked about at our Investor Day. We still expect progress towards that goal to be nonlinear, given incremental headwinds to reported margins in fiscal 2027 from the new transaction model. Third-quarter free cash flow was $430 million, which benefited from the earlier timing of billings in the quarter and lower cash tax payments. As a reminder, our free cash flow growth rate this year is also skewed by the transition to annual billings for most multiyear contracts. This tailwind will also significantly diminish next year. Moving on to capital allocation, we purchased approximately 1.2 million shares for $361 million at an average price of approximately $306 per share. Year to date, we have repurchased 3.7 million shares for approximately $1.07 billion. Turning to guidance, I will again speak to the numbers excluding the impact of the new transaction model and in constant currency, to give you a clearer view of the underlying dynamics of the business. In the earnings deck, you will see that we split the impact of the new model and currency movements for our fiscal 2026 guidance. We've assumed the underlying momentum of the business remains consistent with previous quarters for the remainder of fiscal 2026. We have a large pool of EBA and product subscription renewals to close in the quarter of the year. And we'll also have our toughest new transaction model billings and revenue growth with last year. The macroeconomic environment seems broadly stable, but macro uncertainty remains elevated, and we remain mindful of potential disruption as we continue to execute our sales and marketing optimization plan. So we built some risk into our guidance range for the remainder of fiscal 2026, and expect to again reflect these factors in our fiscal 2027 outlook in February. We remain disciplined and focused on the controllable factors that drive our revenue, operating margin, earnings per share, and capital allocation, which are the key building blocks of free cash flow per share. Reflecting all this, we've raised our billings guidance range to between $7.465 billion and $7.525 billion and raised our revenue guidance range to between $7.15 billion and $7.165 billion, which flows through the current momentum of the business through our full-year underlying guidance. The bottom end of our full-year guidance range reflects some macroeconomic risk for the final quarter of the year. We've also raised our non-GAAP operating margin guidance for the year to approximately 37.5% or approximately 40.5% on an underlying basis, which excludes the impact of the new transaction model. We've also raised our free cash flow guidance range to between $2.26 billion and $2.29 billion. As we said last February, utilization of U.S. deferred tax assets will mean we pay little U.S. federal cash tax in fiscal 2026. We do not, therefore, get incremental cash benefit from the One Big Beautiful Bill Act this year. Further, we now expect to buy back approximately $1.3 billion of stock, which is at the high end of our previous guidance and a 50% increase compared to fiscal 2025. The slide deck on our website has more details on modeling assumptions for the fourth quarter and full-year fiscal 2026. Andrew, back to you. Andrew Anagnost: Thank you, Janesh. Autodesk is focused on the convergence of design and make in the cloud, enabled by platform, industry clouds, and AI. We are at the forefront of convergence because we've been evolving and investing in the business models, products, and platforms, and go-to-market that capitalize on it. We are at the forefront of neural AI foundation models we are deeply integrating into our products. Not as a surface-level add-on, and have access to decades of digital data enabling us to generate greater value for the next wave of AI for the physical world. AI will enable inference across tasks, workflows, and systems which will supercharge convergence. Let me give you a few examples of our progress in the quarter. Our customers in AECO architecture, engineering, construction, and operations, are demanding convergence to reduce risk, increase quality, and optimize costs and resource use during the design and build phase of an asset. And to yield enhanced efficiency, resilience, and reuse during the operations and maintenance phase of an asset. Autodesk Construction Cloud has growing momentum with owners, designers, GCs, and subcontractors seeking to converge design and construction workflows. For example, a leading global food processor and asset owner is migrating over 700 active projects from a competitive solution to address challenges with end-to-end capital project management. Infrastructure owners, like the South Carolina Department of Transportation, will replace legacy tools with Autodesk solutions to execute long-term plans to improve state infrastructure and resolve maintenance and resilience challenges. Integrated design-build companies like Daiwa House Industry Company Limited, a pioneer of industrialized construction in Japan, is adopting Autodesk Construction Cloud and Autodesk Informed Design to connect its manufacturing and construction processes, placing Autodesk at the center of its common data environment for building systems. And general contractors like Flynn Group are migrating to ACC to unify design intent with field execution in a single data environment to improve project coordination and efficiency. These stories have a common theme: converging people, processes, and data across the project lifecycle to increase efficiency and resilience while decreasing risk. Our comprehensive end-to-end industry clouds and platform drive convergence and extend our footprint further into the larger growth segments like infrastructure and construction that we discussed at Investor Day. All this is reflected in our sustained strong revenue and new customer momentum in infrastructure and construction. Our manufacturing customers are also demanding convergence to drive cost and research efficiency during the design and make process by converging product development workflows in the cloud, leveraging centralized and granular data in unified data models, and embracing AI-driven automation capable of industry transformation. For example, industrial machinery companies like Micromatic are replacing disconnected competitive solutions with our unified design and make platform to connect data and workflows, which increases collaboration and drives efficiency and speed to market through component reuse and fast, reliable iterations. Machinists at an American cosmetics company will save hours per week by using Fusion for manufacturing and simulation to automate nesting, toolpaths, 3D printing, and programming of multi-axis machines to create spare parts. To further strengthen and scale its integrated design and manufacturing processes, Total Environment is leveraging Fusion's advanced capabilities in manufacturing simulation, design, and data management. By unifying workflows on a single platform, the company will eliminate disconnected tools, enhance collaboration, and improve efficiency across its operations. And a French automobile manufacturer is adopting Fusion to produce motor prototypes after a benchmarking analysis showed the Fusion platform could complete a machining task in twelve hours, which is ten and fifteen days faster, respectively, than competitive solutions. Converged data opens up new opportunities for Autodesk. As customers seek to drive efficient innovation, Fusion is driving strong growth with extension attach rates increasing and driving average sales prices higher. And we're delivering meaningful productivity gains to customers where we deploy AI. We have continued to see success with our AI-powered sketch auto constraint infusion. Since its launch this year, the AI model has delivered over 2.6 million constraints and has been retrained and the UX improved all along the way. The acceptance rates for auto constraint suggestions to commercial users have grown to more than 60%, with 90% of those sketches fully constrained. In education, Wake Technical Community College, Kimley-Horn, and Autodesk have entered a strategic partnership to prepare more than 6,000 students for high-demand careers in design, engineering, and construction. This initiative will integrate Fusion, Forma, Civil 3D, and Autodesk Construction Cloud into WTCC's coursework with Kimley-Horn's nationally recognized internship program, creating a direct pipeline from classroom to career. And lastly, we continue to find new ways for our customers to consume our products and services in ways that work best for them. For example, a multidisciplinary AEC consultancy firm is using flex consumption to rapidly scale and manage projects across multidisciplinary teams and distributed supply chains to accelerate project delivery and reduce risk. Attractive long-term secular growth markets, our focused strategy of delivering ever more valuable and connected solutions to our customers, and a resilient business are generating strong and sustained momentum both in absolute terms and relative to peers. Our disciplined execution is driving greater operational velocity and efficiency. We are deploying capital to grow the business, further reduce share count, and enhance value creation over time. In combination, we believe these factors will deliver sustainable shareholder value over many years. Operator, we would now like to open the call up for questions. Operator: As a reminder, to ask a question, you will need to press 11 on your telephone. To remove yourself from the queue, you may press 11 again. Our first question comes from the line of Saket Kalia of Barclays. Please go ahead, Saket. Saket Kalia: Okay. Great. Hey, guys. Thanks for taking my questions here and great to see the better results. Well done. Andrew Anagnost: Thank you. Absolutely. Saket Kalia: Andrew, maybe to start with you. I'd love to pick up on the theme from Analyst Day a little bit and see if you could just weigh in on sort of the seats versus consumption AI monetization debate for Autodesk. But maybe also as part of that, touch on your broader ecosystem of partners and customers. That make sense? Andrew Anagnost: Yeah. That does make sense. And thanks for that question. It's very apropos. So look, there's three things we want to pay attention to here. The first one is there's still a fundamental capacity challenge in all the industries we serve, AEC and manufacturing. There isn't enough current capacity to meet all the demand for what needs to be built or the supply chain needs that need to be throughput inside of both manufacturing and AEC. So we have a capacity challenge. The second thing I think is really important is in the future, there's still going to be projects that require intensive human engagement in order to successfully execute. They're going to be more complex. But there's also going to be projects in the future where there's less requirement for human engagement. Machines are going to execute more on these things. And there's going to be a balance between these two. You know? And the last thing is something I've been saying over and over again. You know? Our goal is to decrease the number of people that are working on a particular project but increase the number of projects that our customers and our ecosystem are working on. And if you do that, what you're going to see is we're going to be capturing incremental consumption value to the things that we do, monetizing machine-based execution, providing outcomes, and all things associated with that while also still supporting the people-based work that's going to go on in the ecosystem. This is equally true of our customers. Our customers are going to be seeing their balance shift from sometimes, in some cases, billable hours to also consumptive execution through machine-based execution based on their intellectual property and their IP. And their unique knowledge set. So we're all on the same journey together, but it's going to play out over time. And you're going to see us actually capturing more value and creating more capacity for the industry we need because the industry desperately needs it. Saket Kalia: That's that makes a ton of sense and super helpful. Janesh, maybe for my follow-up for you, appreciate the detailed guide for this year. Was I was wondering if you were able to just give us any color on fiscal 'twenty seven high level as we think about our models. Janesh Moorjani: Hey, Saket. I'm happy to do that. So let me elaborate a little bit on what I said in the prepared remarks. First off, just by way of context, the business is clearly performing very well this year. That said, we've got a lot of business to close, particularly in January. The second thing I'd point out is our sales and marketing optimization plan has gone very well so far. But we are not complete with that. As we touched on this a little bit at Investor Day. So I think there's still some risk of disruption next year. And then finally, while the macroeconomic indicators have been broadly stable, uncertainty does remain elevated in the environment. So just we just think it's best to maintain a prudent posture on our underlying growth for fiscal twenty seven. We're performing very well this year, and we're looking forward to the rest of the year. Saket Kalia: Very helpful. Thanks, guys. Janesh Moorjani: Thank you. Operator: Thank you. Our next question comes from the line of Adam Borg of Stifel. Awesome. And thanks so much for taking the question. Adam Borg: Just on the Autodesk Construction Cloud, it's great to hear the continued traction and even the customer coming over migrating 700 active projects. When you think about your existing Autodesk Construction Cloud installed base, for those existing customers, how penetrated are you in terms of the cost of the projects that are already brought over to Autodesk? Any color around that and the ability to continue selling broader parts of your growing ACC portfolio, be it payments or preconstruction, etcetera, would be really helpful. And then I have a follow-up. Andrew Anagnost: I really like that question. Okay? So first off, let me just start at the fundamental level. Alright? The reason why Construction Cloud's doing so well is that we've got this design to preconstruction through construction execution solution. It's completely unique in the industry. And it's built on a modern platform. This is not an aging platform. That's going to kind of age out of what people need in the future. It's a highly connected AI-ready SaaS-based platform. That's really a huge selling point for us. And what you just mentioned there, Adam, is completely true. As we're acquiring new customers and penetrating new accounts and displacing competitors in lots of accounts, what we're doing is we're starting off with a set of projects. So we're not even fully penetrated in all the projects that we've executed with our customers to date with I mean, in accounts where we are with our customers today. So there is actually not only increased penetration that will happen over time within the accounts we have as new projects come and light up and old projects sunset, but there's also additional expansion just driven by the power of our value prop. Adam Borg: That's really helpful. And maybe just building on the theme of convergence. In design and manufacturing, we talked about this a little bit at Investor Day. But as you think about convergence and the opportunities with fusion over time, how do you think about the PLM market more broadly? For all that? Thanks so much. Andrew Anagnost: Yes. So another great question. Alright? And I really appreciate it. So first off, remember, we're targeted at the mid-market, and that's where there's a lot of growth in supply chain activity. These customers need convergence because they need this end-to-end digital productivity. And I just want to make it super clear to everybody. Most of those customers have nothing. With regards to PLM. They don't have anything. Alright? They may have a data management solution. They may not. Most of their work is actually done through spreadsheets and ad hoc connectivity with some of their ERP systems. They don't have any kind of strong data management or lifecycle solution. We're building a solution for those customers. And we're going to go in there and say, you can get what the big boys have. And you can get the kind of control and the cloud visibility and the cloud data flow that was reserved only to a few. And they need a modern platform. They need a SaaS-based platform. They need what we're bringing with Fusion. So that's how I look at the market. We built these capabilities in the Fusion. We're continuing to enhance them, and we're already starting to see success with small accounts of two to three users expanding to larger accounts because we have these tools that are really hard for a lot of people in the mid-market to get and deploy. Adam Borg: Incredibly helpful. Thanks again. Operator: Thanks for the questions. Thank you. Our next question comes from the line of Jay Vleeschhouwer of Griffin Securities. Please go ahead, Jay. Jay Vleeschhouwer: Thank you. Good evening. Andrew, my first question for you is a corollary to the question I asked you a quarter ago about the pace of new technology adoption. And the question has to do with something interesting you said at AU. I think it might have been a main stage you said, as far as your customer base is concerned, that, quote, no one gets left behind. End quote. Which is an important general commitment. But what are the practicalities of that in terms of customer migration, packaging, promotion, all those sorts of things that you've done or will need to do with regard to migrating your customers in the way that you implied? Andrew Anagnost: Yeah. So look. We're attacking this from multiple vectors. Okay? So first off, packaging is the first one. Right? As you know, if you're a collections customer or a Revit customer, you get the Forma design application shipped with your subscription. So you're already getting something that is you're paying for the future and the present. Alright? So you're capturing the value right there. And you're part of the ecosystem. The other thing that we're doing is we're also making sure that we have the CDE available to as many customers as possible. That's Forma data management. And we'll talk more about that in the future, which is a really important piece of the puzzle as well. The other thing that's really important, and it needs to get airtime because you're going to see something similar evolve in the Fusion world as well as we talked about Revit as rolling out as the first Forma connected client next year. And what that means is what we're doing is we're tightly connecting the workflows between the feature-deep desktop product that customers use today and the evolving emerging product they'll be using tomorrow. So that they can seamlessly move between these two products in such a way that they can get the benefit of one while also harnessing simply and easily the benefit of the other. That's a really important part of the strategy as we move forward. Because the adoption does take time. It takes time for people to change these things. And we're also hyper-focused, especially on the AI side, on rolling out features that may not look sexy at the headline level, but are real productivity enhancers for our customers that get real adoption. What you're seeing with auto-constrained infusion is a great example of that. It's a highly adopted feature. Now explaining it to everybody exactly what it does usually requires a video, but to a customer, they get it. And they love it. They accept these things at, like, 60% acceptance rates. Some of these sketches are 90% constrained. It's the kind of stuff that you're going to see us continue to roll out that really makes a difference in how our customers work. Jay Vleeschhouwer: Thank you for that. Janesh, given the revenue upside across each of the segments, could you comment on any new or incremental trends you're seeing in usage telemetry, either by vertical or geo or standalone product versus collections, anything of that kind? In terms of the usage component that helped drive some of that growth. Within AUC manufacturing and so forth. Janesh Moorjani: Jay, thanks. What I'd say is the momentum in Q3 continued from the first half. And the trends we saw in Q3 were similar to what we saw in Q2 as well. And you see that strength reflected in the different product lines and the different areas of the business. I touched on some of the areas within AECO, for example, around data centers, infrastructure, and industrial that were all bright spots again. And you see that reflected in products as well. Similarly, when you look at the Autodesk store and some of our emerging geographies that did well, you'll see the trends reflected in those, the products that get sold through those routes as well. So overall, I'd say it was very consistent with what we had seen in Q2. Nothing new that I would highlight as an emerging trend. Jay Vleeschhouwer: Thank you. Operator: Thank you. Our next question comes from the line of Jason Celino of KeyBanc Capital Markets. Your line is open, Jason. Jason Celino: Hey. Great. Thanks for taking my question. I wanted to ask about the normalized growth you saw this quarter, the 12%. You know, again, similar to last quarter, slight acceleration. But was there, like, what was the inorganic contribution to that normalized number? I'm just trying to understand if there was some modest acceleration. And if there was, you know, what do you think drove that? Janesh Moorjani: Yeah. I'm happy to touch on that. There was nothing unusual with respect to M&A activity in Q3 that affected those underlying growth rates. I'd say what we saw there was just the continuing momentum we've seen in the business, as I mentioned just a moment ago. The sources of where that outperformance came from in terms of the upfront revenue, the Autodesk store, and stronger billings linearity during the quarter, I think all of those played a role in helping us get to the ultimate outcome that we delivered over here. So overall, it was a strong quarter across the board. The team executed really well, and I think that's what you're seeing reflected in the numbers. Jason Celino: Okay. Great. No. That's helpful. And then when we think about the commentary around the EBA cohorts that you have for Q4, I'm just curious what type of behavior you've seen so far from, like, a renewal standpoint or if customers are willing to engage earlier, just curious if you have any tidbits that will be helpful there. Thank you. Janesh Moorjani: Jason, in terms of what we saw in Q3 was very strong engagement from many of those customers. We closed all the business that we were expecting to close. And if I think about some of the typical metrics that we have around attach rates and so forth, those all played out as we expected they would. Q4 is our largest quarter for EBA renewals, and we also have a very large product subscriptions renewal cohort to close here in this quarter. Q4 is heavily weighted towards January, so there's still a lot that we need to get done. But, again, the team did well here in Q3, and that momentum has continued nicely. Jason Celino: Okay. Wonderful. Thank you. Operator: Thank you. Our next question comes from the line of Taylor McGinnis of UBS. Please go ahead, Taylor. Taylor McGinnis: Yeah. Hi. Thanks so much for taking my questions. Andrew, first one for you. Just on you mentioned earlier about still some elevated uncertainty out there, but it sounds like you guys are seeing some strength in areas like data centers, industrials, and whatnot. When you speak with customers regarding their spending plans across AEC manufacturing and M&E for calendar 2026, or fiscal year 2027? I guess any early insights that you could share with the group in terms of what you guys are expecting to see? Andrew Anagnost: Yeah. You know, customers aren't flagging any differences in their spending pattern. Alright? I think one of the things that's really, really important to note is one, the current momentum is going to continue a little bit. And also, what the customers are looking for is they're preparing for future productivity enhancements. So everyone's investing in their digital infrastructure. It's trying to get ready for any changes in the demand patterns, what sector might be more important as we move forward. So most of our customers are flagging a continuation of their investment. Some areas are flagging a little bit more investment because they've been kind of maybe slow on the investment in the past, but we don't see anything changing in terms of the consistency level right there. Taylor McGinnis: Perfect. Thank you. And then, Janesh, maybe just one for you. On billings growth, you made several comments in the prepared remarks just about how growth has been elevated this year because of the new transaction model and also because of the larger base of multiyear billings customers, and we're going to start to lap that going into next year and see some moderation in growth. So can you just help us unpack the mechanics there a little bit more? So as we look into 2027, could we start to see, if we adjust for FX and the new transaction model, revenue growth and billings growth start to align with one another? Or is it possible that we could actually see some tougher comps and maybe there's a divergence between the two? Any additional color you can give there, I think would be helpful. Janesh Moorjani: Taylor, I'll break that into two parts. One is around the underlying business performance that you mentioned and the second is just the mechanical aspects of modeling the growth for fiscal 2027. So first, in terms of just the underlying growth that we see in the business, we feel very good about this year. And if you look back at the last couple of years, we've demonstrated consistent growth, and that trend has continued this year. We've also talked before about the diversification of our business across industries, across geographies, and customer sizes, that's a strength for us. And again, we saw that play out here in Q3 as well. If I look ahead, we're excited by the growth potential of businesses like Fusion, Infrastructure, and some of the others that we outlined at Investor Day. So overall, I think we're executing really well, including on the AI and road map, and we feel very well positioned in that regard. So if I think about the growth for the future, I think all of those things give me confidence. But also when I guide for next year, I will consider, as I mentioned, the go-to-market optimization and the macro risks that I touched on at the start of this call. And then in terms of some of the underlying mechanics, thank you for the question. I think it's actually helpful to spell out what we expect to see next year. So to break that apart, if I think about the billings and free cash flow growth rates this year, they have been inflated because of the transition to annual billings, so most multiyear contracts. That's a business model transition that we expect to complete during Q1 of next year. And so we expect that reported billings and free cash flow growth will start to normalize during next year. Billings and revenue growth rates have also been inflated this year from the new transaction model, for which we provide the details separately on an underlying basis. And on that transition, we expect a smaller impact from that in '27 than we had in '26. We'll also have incremental headwinds to reported operating margins from the new model next year. But ultimately, as you know, these are just near-term accounting effects. And the underlying business has been performing consistently well. Our goal is to try and get to as reported numbers as soon as we can. So that will be our focus in the future. Taylor McGinnis: Great. Thanks for all the color. Janesh Moorjani: Of course. Operator: Thank you. Our next question comes from the line of Elizabeth Porter of Morgan Stanley. Please go ahead, Elizabeth. Elizabeth Porter: Great. Thanks so much for the question. I wanted to follow-up regarding some of the new AI capabilities like auto constraints, which appear to have high rates and measurable productivity gains. The question is, are these product improvements translating into observable changes in multiproduct adoption or expansion activity? And just as the platform overall delivers more value with AI, how are you thinking about the pricing power? Any sort of larger, more periodic price increases, or a steadier cadence tied to just incremental AI-driven capabilities? Is that an opportunity that you look forward to? Thank you. Andrew Anagnost: Yeah. So thank you for the question, Elizabeth. So first off, let's be very clear. This is a multiyear journey here that we're on. Alright? And I want to be clear that we're going to be kind of moving along with our customers here and focusing on key areas of adoption and finding levers of productivity that make a real impact on them. We're starting with tasks. Auto constraints is a classic example of a task within the modeling. We're going to do a lot of that. That task automation is highly protective of our existing business and the hour. What the customers love is they see large incremental productivity increases that are not classically easy to replicate in a traditional kind of development model and feature creation model. So task automation is highly protective of the existing business. It is highly retentive, and we see some of that with some of the satisfaction ratings we get with some of this technology move forward. We're going to be moving more and more into workflow automations as you see us move next year. We talked about some of this at AU. We showed some pretty compelling workflows between various products and across various products from design to preconstruction planning and things like that. Those workflow automations are going to ultimately offer additional monetization opportunities because some of it will be included with the subscription, but some of it will not. Will be charged for incrementally. And as the customers adopt those and as we find the right workflow levers, you're going to see us start to capture some of that value. Now as we move down the curve into systems level optimization, those are going to capture the most value. They're further down in the pipeline, but they're also the kind of things that have huge impacts on our customers and huge value delivery. And we're going to capture some of that value. We're going to share some of it with our customers, but we're going to capture that value. So face automations are highly retentive. They have retentive effects. You can see that with the way the customers are satisfied with the product and what they see in the product. The workflow automations are going to be also highly retentive, but they're also going to offer incremental monetization opportunities and system level optimizations will offer more monetization opportunities. But this is going to take time. Elizabeth Porter: Great. And then just as a follow-up, I wanted to ask on the margins, where it was really impressive to see the underlying margin kind of move up in the full-year guide. The question is, where are you seeing the most outsized success that's driving up the full-year view? And what are the levers that are having more of an impact in the near term versus what can be more of a driver next year for the underlying margin trajectory? Janesh Moorjani: Elizabeth, maybe I'll take that one. I think the underlying levers are the same near term as well as longer term. The biggest lever in terms of achieving our margin targets over the long term will be our go-to-market optimization. And on that, we've already made great progress so far, and that will ultimately further reduce our sales and marketing as a percentage of revenue. We also have inherent operating leverage, which is something that we've demonstrated for a few years now. And so that shows up in the near-term numbers, and that will also be a driver for us longer term. And embedded in that operating leverage, there are a few puts and takes. You know, to start with, on the gross margin front, we expect that cloud and AI workloads will be accretive to gross profit dollars, but they will pose a headwind to gross margin as they scale. We think that's actually a sign of success if that happens in terms of our strategy for adoption working quite nicely. On the R&D side, as we've shared before, we'll continue to prioritize investments in innovation and AI-driven initiatives. But at the same time drive efficiency through common components in the platform. And on the G&A side, we will just scale efficiently as we continue to grow the business. So those are some of the things that I see. And in terms of the rate of progress of getting to the 41% margin target that we outlined, as I've mentioned earlier, the path to getting there will be nonlinear, just given the additional margin headwinds we expect from the new transaction model this year. But overall, we feel we are well on our way to achieving the target, and we've already raised the current year outlook here by 50 basis points. So we feel pretty good about that. Elizabeth Porter: Thank you. Operator: Thank you. Our next question comes from the line of Josh Tilton of Wolfe Research. Your line is open, Josh. Josh Tilton: Hey, guys. Thanks for sneaking me in, and congrats on another great quarter. Two for me. One more near term, one maybe long term. Just in the near term, you know, I think if I look back, this is probably one of the biggest to the billings growth guide going into a Q4 that we've seen maybe ever. And I'm just trying to understand, or maybe you could help me unpack what exactly is driving that near-term performance. And then my follow-up to that is just more longer term. The agency transition seems to be going well. It's wouldn't say well underway, but, you know, I feel like it's hit maybe critical mass to some extent. Can you maybe talk to some of the levers that you have to incentivize this newly formed channel to drive better new business growth for you guys going forward? Thanks. Janesh Moorjani: Josh, maybe I'll start. In terms of the outperformance that we had here in the third quarter, there's a couple of sources. One is, as I mentioned, just consistent strong execution from the team, which is something that we are all very proud about. But the second is also just in terms of the guidance philosophy that we had and the approach that we took entering the quarter where, as you know, against the low end of our billings guidance, we had assumed a pretty severe macro scenario, which we had been quite transparent about. That didn't play out. The broader macroeconomic environment was relatively stable. I think you saw some of the benefits of that here as well. And as if I think about the Q4 view on that, and the extent of risk that we've got baked in, the guidance range, particularly on billings, is a little bit of risk baked in at the lower end of the range. But given that we've got basically just a little over two months here left to go in the year, we didn't feel like we needed to take as a dim view of the macro Q4 as we had previously taken. Andrew Anagnost: And to the second part, Josh, I'll weigh in on that a little bit. Okay? So there's a couple of things that we're enabling with the new transaction. One, we have better customer intelligence, which is going to allow us to be more efficient with our partner engagements. The other one is we're working really hard to automate more of the things that are associated with renewals. So if you look at the way we want to move forward, you're going to see us incenting the channel more on new business than on renewals, which is going to align the channel with kind of our long-term objectives. It's easier to make renewals now, so we should be paying less on renewals. And we should be paying more on new business so that the channel can build the right kind of capacity for the new business and hunt a bit more and renew in a more automated way. So look for us to continue to push that as we head into next year. Tighter intelligence going into the channel, more efficiency, more automation, more self-service tied to renewals. And a stronger emphasis on new business generation. Josh Tilton: Love to hear it. Thank you so much. Operator: Thank you. Our next question comes from the line of Joe Vruwink of Baird. Your line is open, Joe. Joe Vruwink: Hi, great. Thanks for taking my question. I wanted to go back to the FY 2027 outlook. And I guess what I really want to ask is, do you need the same level of prudence when you frame the forward outlook like you have been using? And I just sit here and appreciate that this year, started eight to nine. It looks like it'll end closer to eleven. There's something to be said about prudence, but also nothing wrong with communicating strength when it's evident. And I think you're not only seeing strength, but it would seem like next year, you know, definitely end of stages and some transitional elements, early stages on things like consumption or cloud adoption that can contribute more. I'm just wondering if some of that factors into a different approach to the Outlook. Janesh Moorjani: Hey, Joe. So, look. On fiscal twenty seven, it will make sense to talk about the specifics when we are actually guiding to fiscal twenty twenty seven in February. What I wanted to do today is just share our overall enthusiasm for how we're executing here in Q3. I talked about some of the momentum that we're seeing and some of the factors that continue to excite me about the business in the long run and just be transparent about some of the factors I'll consider when I set guidance. In terms of the specific levels of those, we will talk about those on the next call. Joe Vruwink: Okay. No. That's fair enough. At AU, there are some good sessions from your large customers on how they've set up kind of centralized Autodesk development teams, and you have different regional teams that are now building around platform services in a coordinated way. You know, a lot more talk about how agents are factoring into what these teams are now starting to do. I guess there's this idea still percolating out there that AI is going to make it easier for your large E&C customers, these same entities, to maybe just do more internally. And I guess, I want to ask what you're seeing on this topic and really when we see a large E&C account, talk about data scientists on staff and, you know, what they're doing. We really think, well, Autodesk is ultimately having a role here? Andrew Anagnost: Yeah. You should absolutely think that, Joe. Okay? Our goal is to make it easier for them to apply their IP with their data scientists to the workflows that make the most impact on their business. But our platform is going to be everywhere in this. And the services and agents we build associated with our platform are going to be core to how they create that value from their IT. Incrementally above some of the models that we build ourselves and that we deploy into their environments. We want to coordinate and work with agents they may build internally with the agents that we have, and one should be augmenting the other. So look for our platform to be everywhere that these customers actually execute and incrementally build capabilities on. Joe Vruwink: Okay. Thank you. Operator: Next question comes from the line of Bhavin Shah of Deutsche Bank. Your line is open, Bhavin. Bhavin Shah: Great. Thanks for taking my questions and congrats on the strong results. Janesh, I know you spoke about this briefly in your prepared remarks, but in terms of channel productivity, excuse me, how much time is still spent on operational elements? When do you think the channel gets back to full productivity? And is there any kind of impact also with all the M&A activity happening with your resellers? Janesh Moorjani: Yeah. We continue to address some of the operational friction that partners faced on the new transaction model. Andrew referenced that as well. I think we've made very good progress, and I think much of that is behind us at this point in time. There's a bit more to be done, but we are well on our way. We saw the EMEA partners get their first renewals here in September on the new transaction model, and that generally went as we expected it would. And I think at this point, we've lapped all of the first annual renewals. So in terms of the future, we continue to focus on how we and our partners can deliver more valuable and data-driven and connected products and services to our customers. We have seen, you know, the strategy working quite nicely, particularly at the low end where many of the customers previously used to buy from the non-contracted partners or the silver partners are now buying from us directly on the store. And some of our larger partners are focused on continuing to build out value-added services that allow them to build more connectivity and offer better solutions to customers, which then works quite nicely for us in the long term as well. Bhavin Shah: That's helpful there. And as a follow-up, Andrew, maybe just for you, there's been some recent headlines about agents turning 2D sketches into 3D models via CAD software. As innovation continues to evolve here, what role can Autodesk play? How are you thinking about evolving the product capabilities as agents and copilots to turn sketches into the models continues to evolve? Andrew Anagnost: I think you should assume that the level of data that Autodesk has in this particular area and the level of focus will certainly excel above anything else you see out there. We just focus where the biggest returns are right now. Bhavin Shah: Makes sense to me. Thanks for taking my questions. Janesh Moorjani: Thank you. Operator: Thank you. Our next question comes from the line of Tyler Radke of Citi. Please go ahead, Tyler. Tyler Radke: Yes. Thank you for taking the question. So the direct revenue has grown I think it was up 85% this quarter. You called out strength in the online store, the Autodesk store. Just wondering, you know, is this strength is this coming in well above your expectations? And how should we just think about the mechanics of taking more business direct and potentially that being a tailwind to the reported revenue that we're seeing? Janesh Moorjani: Tyler, I'd say in Q3, things were as we expected they would be. We were expecting to see an increase in the mix of direct revenue as the new transaction model continues to scale. So that generally played out the way we expected it would. And in terms of the impact of that on the model, it does affect the as-reported numbers, as you know, which is why we also provide the views on an underlying basis. I'd say the store strength has continued for some time. A portion of that might be channel shift, but a lot of it is also just general strength we've seen particularly in a number of the countries around the world that we've talked about where we haven't rolled out the new transaction model, we've been seeing strength in those countries as well. So I think it is a bit broader based on that. Tyler Radke: Great. Helpful. And then, Janesh, just on the underlying growth, I know you got some questions on this, specifically as we think about FY 'twenty seven guidance. But you know, you started off the year in sort of the high, single-digit ballpark. And I think we look at the Q4 guide, normalized growth is closer to kind of the low teens. Is that a fair characteristic of where the underlying growth of the business is today? Maybe there's some one-up or one-time revenue in that Q4 number as it relates to EBAs. Just help us understand, like, where is that underlying growth of the business? In your view now? And I assume that's maybe a few points higher than it was at the beginning of the year. Janesh Moorjani: Tyler, at the start of the year, when we laid out our guidance, again, we had prudent for a variety of reasons. It was also my first guidance for the full year as CFO. We had just done a restructuring. There were a number of other factors as well that played into that. But if I and at that point, I had mentioned that I viewed the business as being a consistent and resilient business, and I think that played out quite nicely. If you look at the growth we've seen over the last couple of years, and then if I look at this year, we've had very consistent growth across the three quarters of this year and that same consistency is implied in the guide for Q4 as well. So we feel very good about the way we've executed and all the irons we have in the fire to continue to sustain our momentum in the future. But again, we will consider our overall risks around go-to-market execution as well as the macro when we guide. Tyler Radke: Thank you. Operator: Thank you. Our next question comes from the line of Ken Wong of Oppenheimer and Company. Please go ahead, Ken. Ken Wong: Thank you for taking my question. Andrew, I wanted to circle back on a comment that you made about the incentive structure to partners. Realized that you guys are taking it down on renewal to incentivize some hunting. Any early feedback from partners? And I realized it doesn't take effect usually until February, but any early behavioral changes that you guys are noticing from the channel? Andrew Anagnost: Yeah. Nothing pronounced. Okay? No early changes. Obviously, partners always have lots of questions when we change their incentive structure. But generally speaking, they get what we're trying to do, and they understand what's going on here. We're not trying to take money out of the channel ecosystem. We're trying to shift how it gets paid out. Makes total sense to them. We haven't seen any initial kind of changes in their behavior right now at all. Ken Wong: Okay. Perfect. And then on the OBVA side, Janesh, I realize you're not expecting any tailwinds on the free cash side. Are you guys seeing any early impact on the top line in terms of kind of customer spending behavior or any customer project activity? Janesh Moorjani: Nothing that I would directly attribute to the One Big Beautiful Bill Act yet. Ken Wong: Okay. Great. Thank you, guys. Janesh Moorjani: Thank you. Operator: Thank you. Our next question comes from the line of Koji Ikeda of Bank of America. Your question, please, Koji. Koji Ikeda: Yeah. Hey, guys. Thanks for taking the questions. I wanted to follow-up on a previous question on free cash flow. And Janesh, I think you mentioned there's about two more quarters left before free cash flow normalization. Did I hear that right? And then beyond that, what should quarterly free cash flow seasonality look like? Is there a fiscal year example from the past that we could look at that would be a good representation of what it would look like going forward? Janesh Moorjani: Yes. Koji, the comment earlier was around the growth rates that we would expect will come down. If I think about the app dollars of billings that we have at this point in time associated with the change in the multiyear to annual billing transition, I think that that piece is done. But in terms of thinking about cash flow and providing maybe a general rule of thumb, I would say holding aside any significant discrete items, we generally would expect free cash flow growth to be correlated with our underlying non-GAAP net income growth. And, of course, we will call out any large discrete items when we provide guidance. Koji Ikeda: Got it. And then maybe a follow-up here question for Andrew and thinking about the AI strategy and the data access strategy for AI through MCP, and API calls. How have customer usage trends been around there? And any update on how we should be thinking about any timing of the monetization opportunity with the data access strategy. Thank you. Andrew Anagnost: Yeah. So there's actually fairly robust use of some of our APIs by the customers. And, you know, also we'll be monetizing some of that access as well, and a lot of customers are expecting that. Most customers won't be impacted by that, but those customers that are most heavily using machine-based kind of applications associated with our APIs will probably see impacts in terms of billings associated with their usage. Right? Again, the AI monetization will play out over time. The API monetization will play out over time. But MCPs and APIs are definitely another source of monetization that you'll see us pulling the lever for as we move forward. Koji Ikeda: Thank you. Andrew Anagnost: Thank you, Koji. Operator: Thank you. Our next question comes from the line of Michael Turrin of Wells Fargo Securities. Michael Turrin: Hey. Thanks for squeezing me in. I'll give you a chance to summarize some of the prior comments. I think high level the question is you're raising numbers across the board for fiscal twenty twenty six, it's not something we're seeing a whole lot of across software these days. So maybe just expand on your perspective around what's driving that and how much of that is beyond the scope of just macro and business model changes? And then on cats, specifically, it's another quarter of standout growth, 15%. So maybe touch on that segment and if there are any specific dynamics to be mindful of there as well. Thank you. Janesh Moorjani: Yes. I'm happy to touch on both of those. If I had to summarize Q3, I would say it reflects the consistent momentum we've seen from sustained execution this year. Against the backdrop of a stable macro, while in the guide at the lower end, we had assumed that the macro would worsen. So I think it's both our execution as well as the more prudent guidance assumptions that didn't play out. In terms of the growth of the AutoCAD business, there's a few factors there. That growth is partly affected by just the mechanical accounting on the new transaction model as well. So I think that's part of what you're seeing. But, also, we talked about strength in the Autodesk store and strength in emerging countries like India and LatAm and The Middle East. And some of the AutoCAD strengths that we've seen come from those countries and from the Autodesk store as well. Andrew Anagnost: You know, Michael, I'll just add one more thing to this because I have to. You know, we have been making some serious and important strategic decisions over the last three years about how our business is structured and how we move forward. You're seeing the results. Alright? These are the results that we ultimately said we were going to deliver, and a result of those investments and those changes. They were hard changes, difficult lifts. Now you're seeing the performance associated with those lifts. Michael Turrin: Thanks very much. Operator: Thank you. And that is all the time we have for Q&A today. I would now like to turn the conference back to Simon Mays-Smith for closing remarks. Sir? Simon Mays-Smith: Thank you, Latif, and thank you, everyone, for joining us. Looking forward to seeing many of you on the road over the coming weeks. Wishing my fellow Brits a happy Budget Day tomorrow and my fellow Americans a happy Thanksgiving on Thursday. Thanks very much, everyone. Operator: This concludes today's conference call. Thank you for participating. You may now disconnect.
Operator: Good day, and welcome to the Abercrombie & Fitch Co. Third Quarter Fiscal Year 2025 Earnings Call. At this time, all participants are in a listen-only mode. Later, we will conduct a question and answer session. To ask a question, please press 11. If your question hasn't been answered and you'd like to remove yourself from the queue, press 11 again. We ask that you limit yourself to one question and a follow-up. Today's conference is being recorded. At this time, I would like to turn the conference over to Mohit Gupta. Please go ahead. Mohit Gupta: Thank you. Good morning, and welcome to our third quarter 2025 earnings call. Joining me today on the call are Fran Horowitz, Chief Executive Officer, Scott D. Lipesky, Chief Operating Officer, and Robert J. Ball, Chief Financial Officer. Fran Horowitz: Earlier this morning, we issued our third quarter earnings release, which is available on our website at corporate.abercrombie.com under the Investors section. Also available on our website is an investor presentation. Please keep in mind that we will make certain forward-looking statements on the call. These statements are subject to the Safe Harbor provisions of the Private Securities Litigation Reform Act of 1995 and are subject to risks and uncertainties that could cause actual results to differ materially from the expectations and assumptions we mention today. These factors and uncertainties are discussed in our reports and filings with the Securities and Exchange Commission. In addition, we will be referring to certain non-GAAP financial measures during the call. Additional details and reconciliations of GAAP to adjusted non-GAAP financial measures are included in the release and in the investor presentation issued earlier this morning. With that, I will turn the call over to Fran. Mohit Gupta: Thanks, Mo, and thanks, everyone, for joining as we head into the important holiday season. I am happy to report our twelfth consecutive quarter of growth, with sales up 7% to a record of $1.3 billion. We again delivered on the goals we outlined for the quarter, with net sales and operating margin both at the high end of our outlook, earnings per share above our expectations, and inventory levels aligned with trend. Along with these strong financial results, we repurchased $100 million worth of shares in the quarter, bringing our total to $350 million or 9% of shares outstanding as of the beginning of the year. Our team continues to stay close to our customers while reading and reacting to the current environment. In the quarter, we made further progress on key brand, regional, and foundational investments. Based on our third quarter momentum and our fourth quarter outlook, we are narrowing our full-year sales outlook towards the top end of the range we provided in August, targeting a strong finish to 2025 on top of a record 2024. Financially, in addition to record net sales, we delivered a gross margin of 62.5% and a 12% operating margin for the quarter, both of which include an adverse tariff impact of around 210 basis points. We exceeded our outlook range on earnings per share, delivering $2.36 for the third quarter. On the regions, we saw continued growth in The Americas with net sales up 7% on balanced traffic gains across channels. In EMEA, total sales increased 7% with comparable sales higher by 2%. Similar to last quarter, strong sales performance in The UK, our largest country in the region, continued to be fueled by localized marketing, inventory distortions, and strategic partnerships. Strength in The UK was partially offset by softness in Germany and the remainder of European markets. In APAC, net sales were down 6% with comparable sales down 12%. Across regions, we remain excited about the significant long-term global growth opportunity for our brands through a blend of go-to-market strategies, including owned and operated, franchise, wholesale, and licensing. Turning to the brands, in line with our expectations, we made sequential improvement in Abercrombie brands. Net sales were down 2% and comparable sales down 7%. We continue to see positive cross-channel traffic to the brand, and we managed inventory tightly, enabling improved AUR trends compared to the first half. The sequential improvement was led by Women's, where we had a good seasonal transition to cold weather categories across top, bottom, and outerwear. In Abercrombie, we continue to remain active in marketing, building on early fall denim and NFL campaigns with our recently announced collaboration with luxury retailer Kimo Sabe. Putting these two brands together was a great way to connect with new and existing customers, offering authentically crafted leather apparel and accessories, highlighting the western trend. Abercrombie Brands has inventory in the right place and a strong marketing plan heading into holiday. We've opened 30 new stores in the third quarter, aiming for a total of 36 this year. We remain focused on bringing the brand back to growth by diligently executing the playbook that has delivered a double-digit CAGR on sales from 2019 on strong double-digit AUR improvement over that time. This holiday, you'll see a lot of what Abercrombie is known for: fashion, comfort, and authenticity. And you'll continue to see it expressed through newness across categories. With this combination of investment across product, voice, and experience, we are aiming for Abercrombie brands to be approximately flat in the fourth quarter on net sales against a record in Q4 last year. We're excited to see that milestone within reach. In Hollister, we saw exceptional growth trends continue with 16% net sales growth in the third quarter. Comparable sales were up 15% on continued strong cross-channel traffic. Both men's and women's contributed to growth in the quarter, and we saw balance across categories. Consistent with our READ and REACT model, we've been keeping inventory tight while continuing to flow in newness, allowing for AUR improvement on lower promotions. Coming up with a very strong back-to-school season, I was proud of the team transition to fall and into holiday. Speaking of holiday, Hollister has some exciting campaigns and collaborations planned that will highlight some must-haves for the season. We kicked off a couple of weeks ago with six college athletes co-designing special items in our collegiate collection for football's rivalry week. And you might have seen yesterday's announcement with Taco Bell, where the brands collaborated on 90s and Y2K styles across graphics and fleece. We are just getting started. And importantly, our team has been reading and reacting and has the right product to support sales throughout the season. We're also enhancing the Hollister brand with investments in physical retail. We are on track to open 25 new stores this year while refreshing more than 35. The theme across our brand portfolio and company is consistent. We remain on offense. From both a brand and regional perspective, we are investing in marketing, stores, and talent to support sustainable long-term growth. We also continue to make opportunistic investments in digital, technology, and business infrastructure to improve the agility and speed needed to support our growing global business. These tech investments have the power to enhance the entire customer journey, especially when paired with AI. We recently deployed AI agents in customer service to improve the experience while driving scale and efficiency. And we're very excited about a new partnership we're kicking off this week with PayPal and Symbio, one of our technology partners in marketplace sales. That will enable agent-to-commerce and AI answer engines like Perplexity, where customers can seamlessly complete transactions directly within their AI conversation without even leaving the chat. As our business continues to evolve, we're making future-focused investments to deliver for customers and strengthen our operating model. And for us, that's really the story of 2025. More than three quarters in, I am proud of how the team has worked through this year, responding to the dynamic tariff environment and evolving with our customers. We are fully prepared for the holiday season, having used these past months and quarters to test and learn and build confidence in our assortment and brand positioning. We've also continued to keep inventory tight with the goal of reducing promotions and clearance selling to mitigate some portion of the tariff cost. With our holiday plans in place, we expect to deliver top-tier profitability and earnings per share, reflecting the consistency of our model. And with that, I'll hand it over to Robert. Robert J. Ball: Fran, and good morning, everyone. Recapping Q3, we delivered record net sales of $1.3 billion, up 7% to last year on a reported basis, at the high end of the range we provided in August. Comparable sales for the quarter were up 3%, and we saw a benefit of approximately 50 basis points from foreign currency. By region, net sales increased 7% in The Americas, 7% in EMEA, partially offset by a 6% decline in APAC. On a comparable sales basis, The Americas was up 4%, EMEA was up 2%, and APAC was down 12%. Across regions, the spread from net sales to comparable sales was driven by net new store openings and third-party channel performance. EMEA also benefited from favorable foreign currency. On the brands, Abercrombie brands' net sales declined 2% with comparable sales down 7%. Consistent with our third-quarter outlook, the sales decline was primarily due to lower AUR, but the AUR decline was less than the first half of the year. Hollister Brands' net sales grew 16% on comparable sales growth of 15%, with both unit growth and AUR improvement from lower promotions. The comp to net sales spread for Abercrombie brands in the quarter was driven by third-party channels along with net store openings. I'll cover the rest of our results on an adjusted non-GAAP basis. Operating margin of 12% of sales was at the top end of the outlook range we provided in August, delivering operating income of $155 million compared to $175 million last year. Adjusted EBITDA margin for the quarter was 15% of sales on adjusted EBITDA of $194 million compared to $219 million last year. The 280 basis point decline in operating margin from Q3 2024 was driven primarily by 210 basis points of tariff expense included in the cost of sales. In addition, as we forecasted in August, third-quarter marketing was up 100 basis points from the prior year. This was partially offset by leverage in general and administrative expense on lower payroll and incentive compensation. The tax rate for the quarter was below our outlook at 29%, driven by outperformance to expectations in EMEA. Net income per diluted share was above our outlook at $2.36 compared to $2.50 last year. Moving to the balance sheet, we exited the quarter with cash and cash equivalents of $606 million and liquidity of approximately $1.06 billion. We also ended the quarter with marketable securities of approximately $25 million. For the quarter, we repurchased $100 million worth of shares, ending the quarter with $950 million remaining on our current share repurchase authorization. Year to date, we repurchased $350 million in shares, totaling 9% of shares outstanding at the beginning of the year. We ended the third quarter in a clean current inventory position with costs up 5% and units up around 1%, and have seen freight and other unit cost mix normalize. Shifting to the outlook, we entered the fourth quarter with momentum, and we are narrowing to the upper end of the full-year sales expectations we provided in August. We continue to reflect tariffs and mitigation, consistent with our second-quarter call commentary, and the team continues to find cost efficiencies through vendor discussions as we plan for 2026. For the full year, we now expect net sales growth to be in the range of 6% to 7% from $4.95 billion in 2024. We've narrowed the range to reflect third-quarter performance and expected fourth-quarter sales. We currently anticipate 60 basis points of favorable foreign currency in the outlook. We continue to expect full-year GAAP operating margin in the range of 13% to 13.5%. As a reminder, this range includes the impact of the $38.6 million benefit from litigation settlement, or around 70 basis points of sales. Also, the assumed tariffs included in the operating margin carry a cost impact of around $90 million for 2025, or 170 basis points of sales. We are forecasting a tax rate around 30%. For earnings per share, we expect diluted weighted average shares of around 48 million, which incorporates the anticipated impact of 2025 share repurchases. Combined with the tax rate, we expect net income per diluted share in the range of $10.20 to $10.50. For clarity, the $38.6 million benefit included in our outlook carries a favorable impact of $0.59 per share. For capital allocation, we continue to expect capital expenditures of approximately $225 million. On stores, we continue to expect to deliver around 100 new experiences, including 60 new stores and 40 rightsizes or remodels. We also expect to be net store openers with our 60 new stores outpacing around 20 anticipated closures. At the current sales and operating margin outlook, we are targeting around $450 million in share repurchases for the year, subject to business performance, share price, and market conditions. For 2025, we expect net sales to be up 4% to 6% from the Q4 2024 level of $1.6 billion. We expect operating margin to be around 14%. We continue to expect lower cost of goods sold from freight at around 150 basis points of sales for the quarter. We also continue to expect $60 million of tariff impact net of mitigation efforts, or around 360 basis points. Operating expense will be around last year as a percentage of sales. We see opportunities to incrementally invest in marketing, but this will be largely offset by leverage in other areas. We expect a Q4 tax rate around 30%. We expect net income per diluted share in the range of $3.40 to $3.70, with diluted weighted average shares expected to be around 47 million, including the anticipated impact of around $100 million in share repurchases for the quarter. To close things out, we entered the fourth quarter ready to compete, with inventory aligned with trend and the right composition. We have great momentum, having delivered against expectations these past three quarters on both top and bottom lines. Our brands are in great shape, with Abercrombie brands making sequential improvement and Hollister brands taking share with impressive growth. We remain on the offense, investing in marketing through key brand collaborations and partnerships, and with store expansion and digital enhancements that enable us to win in the long term. We look forward to a great holiday selling season, and we thank our teams around the globe for putting us in reach of record sales for fiscal 2025. And with that, operator, we are ready for questions. Operator: Thank you. Our first question comes from Dana Telsey with Telsey Advisory Group. Your line is open. Dana Telsey: Hi. Good morning, everyone, and so nice to see the sequential progress. Congratulations. Fran, as you think about the Abercrombie brand and the plan it's tracking to, what did you see by category, men's and women's? Does it differ by channel? How are you seeing the progress of the brand? And then just overall, international, any puts and takes on the different regions and countries. Thank you. Fran Horowitz: Sure. Hey, Dana. Good morning. So super excited about the results we just put up for the third quarter. I mean, total company twelfth consecutive quarter of growth, top line at 7%, comps at 3%. So the Abercrombie brand specifically continues to be strong. This is evidenced by a few things. Our traffic is positive. Our customer file continues to grow. We're seeing nice engagement in our digital and stores channels. Excited about where we're headed for the fourth quarter. The team has been busy at work all year, testing and learning and really reacting to what's happening. Heading into the fourth quarter, well inventoried in denim, fleece, and sweaters, very strong categories for us. As I mentioned also, 30 new stores to date, six more opening up this quarter. So we are fully prepared to compete for the fourth quarter. Robert J. Ball: Yes. Dana, I'll jump in here on the international side. So obviously, we continue to be really excited about the opportunities that we see for EMEA. We have invested in this region. We've got the infrastructure in place to take our brands to the market. This quarter, when you think about puts and takes, UK results were really strong. That's where we've been investing most to improve awareness and service our customers there. We're still in pretty early innings here in Germany and more broadly in the other European countries. We don't really have much of a presence or awareness. So we would anticipate seeing some shorter-term fluctuations here as we ramp those brands. But obviously, we see that as an opportunity to go after. On the APAC side of the house, very similar dynamics here. The market is huge. Our business is relatively small. We're focused on building our brand awareness there and building a stronger presence. So again, not surprising us to see some shorter-term fluctuations. But overall, really confident in the global opportunities that we see for our brands. Obviously committed to getting closer to those customers, deploying our playbook, and ultimately taking these brands to market and growing this business longer term. Dana Telsey: Thank you. Operator: Thank you. Our next question comes from Corey Tarlowe with Jefferies. Your line is open. Corey Tarlowe: Great. Thanks and good morning. Fran, the Hollister momentum has been really impressive. And it seems like the back-to-school momentum is continuing into holiday based on what we're seeing in stores. So just curious on how you expect to continue to build on that momentum as we look ahead and into 2026? Fran Horowitz: Hey, Corey. Good morning. Yes. Wow. What a year we're having with Hollister. Congrats to that entire team. Super excited to grow the business another 16% on last year's 14%, the tenth consecutive quarter of growth. We are seeing balanced growth, Corey, across genders, across categories. We're seeing our AUR growing on lower discounts. The customer file is growing. Our traffic is strong. Most importantly, we're holding our inventory tight so we can really read and react to the business. We've got great momentum heading into holiday seasons. Honestly, there's almost every category is working, which is super, super exciting. I'm sure you saw the announcement yesterday. You know, the Taco Bell partnership for Cyber Monday, we're excited about. So lots of good things happening as we head into the fourth quarter. Corey Tarlowe: That's great. And then just a follow-up for Robert. How best to think about traffic versus ticket as we head into holiday? And then any comments on what that could mean for next year as well? Thanks so much. Robert J. Ball: Yeah. I mean, Corey, so across our brands, when we think about tickets, I guess, touching on tickets real quick, haven't taken any sort of meaningful tickets. We've been talking about this for a couple of quarters now through the holiday season. It's a nice interplay as you think about this holiday season, the best way to drive traffic and to engage with that consumer is going to be through pricing. So our tickets are pretty stable. We have started to think through and take tickets here post-holiday. So you'll start to see some ticket increases across the assortment here with spring deliveries. But the good news is the AURs are growing. We've made sequential improvement from spring into fall across actually both brands, Hollister and A&F. And we're seeing nice positive traffic. So traffic is growing across both Hollister and A&F and across channels, which is great to see. And AURs are headed in the right direction. So customer files are growing, customers are engaged, our teams are locked in with those customer bases. We've got the right inventory here in our stores to compete for the holiday. So we're excited to push through into Q4. Corey Tarlowe: Great. Thanks so much, and best of luck. Operator: Thank you. Next question comes from Matthew Boss with JPMorgan. Your line is open. Matthew Boss: Great, thanks. So Fran, at the Abercrombie brand, could you speak to the cadence of trends that you saw over the course of the third quarter? And elaborate on trends that you're seeing so far in November? And then Robert, could you speak to the composition of inventory across both brands and gross margin puts and takes to consider for the fourth quarter? Robert J. Ball: Yeah. So I'll jump in here. So we obviously had a really strong third quarter delivering our twelfth consecutive quarter of growth, reaching the top end of our guide. Abercrombie, obviously sequential improvement here. Hollister continues to grab share with that customer. And we're excited about the momentum that we're carrying into Q4. In terms of the outlook, I think we're being reasonable, responsible here. We're happy with how the quarter has started, but as you know, Matt, all the volumes ahead of us here and we're ready to compete. As it relates to the inventory side of the house, inventory is in good shape, up 5% year over year at cost, with tariffs being about 3% of that. Units are pretty clean here and in control at up 1%. You know how we operate. We're gonna keep units tight here and aligned with our forward growth expectations by brands. We didn't provide a brand breakout, but as you'd expect, Hollister units are up more than the A&F units. And again, brands are positioned to chase to close out the year. So we feel good about where we sit from an inventory standpoint. On the margin front, gross margin puts and takes here down about 260 basis points year over year in Q3. 210 basis points of that is tariffs. We did see a benefit from freight. It was a smallish benefit from freight and AUR. Then we had a couple of offsets from third-party channels and some inventory reserves to keep ourselves clean headed into holiday. So that's Q3. And then Q4, we'll see some of those themes continue, Matt. You'll see about 360 basis points of impact from tariffs from that roughly $60 million. And then the freight tailwind, as we've been talking about for the past couple of quarters, will continue here and you'll see about 150 basis points of tailwind here for Q4. And then you know how we operate from an AUR standpoint. We've been on this great multiyear journey of AUR growth here. We had a great holiday last season. So we're going to come into the fourth quarter assuming AURs hold. So assuming AUR is flat here as we think about the go forward. Matthew Boss: Great. Best of luck. Robert J. Ball: Thank you. Thanks. Operator: Thank you. Our next question comes from Marni Shapiro with The Retail Tracker. Your line is open. Marni Shapiro: Hey, guys. Congratulations on another great quarter. Best of luck for the holidays in case I forget. Fran Horowitz: Thank you. Marni Shapiro: Can you talk a little bit about the collaborations you've been doing, the NFL, the NCAA, but you also have, you know, Kimo Sabe. You did Crocs. I'm curious, are these all global collaborations or are these specific to The US? And if they're not global, will you do global? And as we think about the brands going forward into '26, I think these pops of excitement are fun. Are they bringing new customers into your store? And should we see an increased or similar cadence into '26? Fran Horowitz: Hey, Marni. Good morning. So, yeah, you know, the collabs are our goal with our collaborations, honestly, is a real authentic branding moment. You know we talk about this a lot. You know, we stay close to our customer and we listen to them, what's important to them, happening in their life moments. That's how we make these decisions to do these collaborations so they are planned, you know, accordingly. The NFL has been very exciting. Yes, it's definitely bringing in new customers. Our goal with that, with the partnership, was about brand awareness and customer acquisition. There's a big crossover with their fandom and our customer base. And we listen to the customer. They told us several years ago how important football fandom was to them, and we took that and tested our, you know, our way into it and have seen a nice success with it. Scott D. Lipesky: Kimo Sabe is another great example. Western was happening. Our consumer was responding to it. We went to an authority in the business and made a terrific collaboration. The Taco Bell one, we're super excited about for Cyber Monday. So as far as 2026 goes, we will continue to listen to our customer. We'll look for authentic moments to make sure that we stay close to them, and we'll continue on this journey. Scott D. Lipesky: Hey, Marni. It's Scott. Just to add on here. It really speaks to where the brands are today. Each brand is in such a strong position, which is enabling us to partner with other strong and great brands. So Fran said, it's a great way to authentically connect to our customers and lots more ahead, and it's been fun for the brands. Marni Shapiro: Fantastic. Thanks, guys. Operator: Thank you. Our next question comes from Alex Stratton with Morgan Stanley. Your line is open. Katie Delahunt: Hi, thank you so much. This is Katie Delahunt on for Alex Stratton. You know, just thinking about, you know, the Abercrombie banner. I know you've all talked about sales growth being about flat for the fourth quarter, but what are the timeline you're thinking about for return to sales growth and then even comp as well? Thank you. Robert J. Ball: Yeah. So, Katie, this it's Robert. Obviously, delivering sequential improvement here in Q3, that's important for us. Teams have been focused on that customer. We're seeing improved product execution. Inventory is clean. And as Fran mentioned, we're placing our bets here for the holiday here in sweaters, fleece, denim. So we're happy about where the brand sits heading into holiday. Marketing is resonating. New collaborations that we just talked about with Marni here. Earlier. Those are great brand moments, and they're driving traffic. Our customer file is growing. We've got strong engagement across both stores and DTC platforms here. So, we're excited about this holiday season. We're aiming to continue to progress here, hold that brand flat against last year's record. Which sets us up well for next year. Katie Delahunt: Got it. Thank you. Operator: Thank you. Our next question comes from Mauricio Serna with UBS. Your line is open. Mauricio Serna: Great. Good morning. Thanks for taking my questions. First, on the marketing front, could you elaborate a little bit more about what you're doing across each brand, you know, the plans for marketing this quarter as you mentioned in the guidance for Q4, that assumes that there's more investment happening. And then maybe on the Abercrombie brands performance in Q3, could you break down like how the comps reflected AUR versus unit or total sales that would be very helpful. Thank you. Robert J. Ball: Yeah. Mauricio, let me jump in here real quick. You know, obviously, not gonna share a ton in terms of our specific marketing plans. We've got some exciting collaborations that we have either have announced in terms of like Taco Bell and you'll see the campaigns kind of continue as we move through the holiday time period. It's been effective. Our traffic is up as we've mentioned a couple of times. Pretty intentional with our marketing here. We're obviously focused on brand building, driving customer engagement, and ultimately supporting both near term and long term. So it's not all just what are we gonna see this quarter, but we're really building these brands for the long-term growth. Obviously, looking at performance as we work to optimize that spend and where we see value, we're going to lean in. And we have two strong healthy brands both exactly where we want them to be. And so we're going to keep our foot on the gas here. As it relates to ANF Q3 performance, you heard us talk about comps there. The down 7%. AUR was sequentially improved, so we did see improvement there. So if you think about the KPIs and the puts and takes, we've seen traffic on the positive side AUR was still down, but sequentially improved here from the first half into the third quarter. And then we had a little bit of pressure here on conversion as well, but conversion also headed in the right direction. So nice to see improvements in conversion, improvements in AUR and continued engagement from our customers with positive traffic. Mauricio Serna: Got it. Thanks so much, and congratulations. Operator: Thanks, Mauricio. Thank you. Our next question comes from Rick Patel with Raymond James. Good morning and congrats on the progress. Rick Patel: Was hoping you could double click on the expectations around SG&A. I know marketing is going to increase, but you touched on being able to mitigate some of that pressure through other areas. So if you can expand on that, that would be great. And then second, just on comps, wondering if there's any variability in performance to flag in The US due to the weather or any regional differences. Thank you. Robert J. Ball: Yeah. So quick on the SG&A side of things. Yeah. We'll see a little bit of increased marketing investment year over year. We've obviously been leaning into this throughout the first part of the year. That will continue, but at a slightly slower clip here in Q4. Q4, obviously, with the sales growth, you're going to see some expense leverage on the G&A side of the house. We've been delivering that throughout the entire year. And given the midpoint of our guide, we wouldn't expect a ton of leverage or deleverage in total at the midpoint of that 4% to 6%. We'll see as we have the rest of the year, as we have all year, as we outperform on the top line, you might see some leverage roll through. But again, we're going to be balanced in our investment approach and where we see opportunities to continue to invest in this business for the longer term, we will. Nothing really to call out from a regional standpoint. You know, we've got a really broad store fleet. So weather in one area, it kind of offsets across the board. Might there be a day or a week here and there that start to see little blips based on weather events when you think about the broader quarter, it kind of all works itself out. And it's been pretty consistent for us across the regions. Rick Patel: Thank you. Operator: Thank you. Our next question comes from Janine Stichter with BTIG. Your line is open. Janine Stichter: Hi, good morning, and congrats on the progress. More question about Abercrombie. It sounds like a lot of the improvement sequentially was led by women's. Can you just elaborate on what's going on in the men's side? If I recall, the comparisons there maybe weren't challenging as what you had in the first half with Abercrombie, but just help us understand what's going on with that side of the business. Fran Horowitz: Hey, Janine. It's Fran. Good morning. Yeah, led by women's, but also seeing nice sequential improvement in men's as well. You know, again, inventories are clean. Excited about where we are for the fourth quarter. Team has been busy at work, testing and learning all season, so or all year, pardon me, heading into the fourth quarter to make sure inventories are where we want them to be. Focused on categories like denim, fleece, and sweaters. So we feel good about the fourth quarter, heading into a big week, right? Excited for seeing all the excitement out there for Black Friday and ready to compete. Janine Stichter: Perfect. And then maybe one for Robert just on the tariff. I think you said $60 million in Q4. Net of mitigation. Any initial thoughts on just how to think about that in the first half of next year as you proceed with more mitigation efforts? Robert J. Ball: Yeah. So we've talked quite a while, Janine, around, you know, our source footprint. We've been obviously at work at this for quite a long time starting way back in tariffs 1.0. We've got a really well-diversified sourcing footprint here. We source from over a dozen countries, which obviously gives us a benefit both from a cost negotiation standpoint as well as speed to market, which is obviously core to our model here. I think it's important for us to take a step back real quick and think about how we're entering this next chapter of tariffs. We're coming at this from a position of strength. We're coming off 15% operating margins last year. To go along with record net sales. The teams have obviously been active. We've got a proven playbook here. So they're leveraging the playbook. They're looking at country of origin footprint as well as finding expense efficiencies. And we've touched on this earlier, but while we haven't moved tickets broadly through the holiday, we are taking targeted price increases here for the spring, so that will start delivering here post-holiday. We've done all of that as we've been navigating 2025. We've delivered record sales for the first three quarters of the year. We're positioned to do the same for the fourth quarter. And we've continued to invest in this business and return cash to shareholders. So bought back $350 million shares year to date, on track to do another $100 million here in the fourth quarter. So we're doing all this all while delivering 13% to 13.5% operating margins. Despite this 170 basis points of tariff impact. So the company is strong. We feel like we're operating and executing at a high level. We'll detail a lot of the components out and the magnitude to some of this stuff in 2026 when we get into our next call. But suffice it to say that we're confident in our ability to navigate this environment. And obviously, our goal is to meaningfully offset these tariff headwinds longer term. Janine Stichter: Perfect. Thanks for the color and best of luck. Robert J. Ball: Yep. Thanks, Janine. Operator: Thank you. Again, to ask a question, please press 11. Our next question comes from Janet Joseph Kloppenburg with JJK Research Associates. Your line is open. Janet Joseph Kloppenburg: Hi, everybody. Congratulations on the upside. I wanted to ask a few questions. I'll give them to you right now. The tariff impact will be greater in the first quarter than the fourth quarter, Robert? I'm not sure on that. And the price increases, when do you expect those to be complete? Like, will we see a big bump in the first quarter and then you'll be done? Maybe you could talk to that cadence. And on cadence, Fran, I thought that the assortments at Abercrombie started to get better in mid-October and continued. And I'm wondering if you saw some response from the consumer on that, unless I'm wrong. And then the fourth question is just on promo levels. What you saw in the third quarter year over year or what you're thinking about for the fourth quarter. Thank you. Robert J. Ball: All right, Janet. Where do you want to start, Robert? Do you want to start and take the tariff one for time? Come back. Let's just keep the tariff conversation going here a little bit. So, okay. Okay. Haven't quantified anything related to 2026. But as you think about how this is gonna cadence out, Janet, you know, for the last that we would expect that a lot of our mitigation tactics, which we've been working at, you know, nine months here, those will start to take hold heading into 2026. So, the hope here and, you know, our confidence level and obviously the pricing adjustments that we've made, which I guess is your second question. Those will start to show up here with spring deliveries. So think late December and into January. You'll start to see those tickets go up. And that'll just kind of work through as the assortments and the newness flows through into the quarter. As you think about vendor negotiations and all those pieces and parts that will also start to impact the first quarter here in 2026. So expectation would be that we would see some relief off of that Q4 tariff headwind of 360 basis points. Fran Horowitz: Thank you. Robert J. Ball: From a promo and Janet Joseph Kloppenburg: Yeah. Promos. And then Fran can talk to the A&F assortments. Go ahead. Go ahead. Finish the promo. Robert J. Ball: Yeah. So from a promo standpoint, you know, we feel good about the cadence that we've been operating under. We've obviously got a track record here of pulling back on promotions and improving AURs here wherever we can. AURs did see sequential improvements from front half into back half across the brands. Hollister is continuing to grow units on lower discounting with higher AURs. So headed into the fourth quarter, we're confident in our promotional plans. We've got the flexibility and we've got the reactivity to adjust demand as we see it come through. We're looking to hold those AURs flat for Q4. And like we do always, we'll come in every day. We'll see if we can pull back on a day of promos here, go a little bit shallower there. But it's been a nice formula for us with this multiyear AUR growth, and we're just going to keep executing that playbook. Fran Horowitz: And then just real quick on the last piece of that question. So very excited to have announced that we made the progress that we committed to at the beginning of the year, that we're seeing sequential improvement in Abercrombie, and really across the board in categories. So we're heading into the fourth quarter. We committed to having clean inventories, and that's where we are. We feel really well positioned, Janet, for the fourth quarter. We are expecting to be or our goal is approximately flat for the fourth quarter. You know, that's on top of a record fourth quarter for last year. We're happy with the start. The customer is resilient. Our file is growing, as I've said before. Our traffic is positive, and we're ready to compete for the fourth quarter. Janet Joseph Kloppenburg: You're talking about A&F? Plan? Fran Horowitz: Listen, I'm talking total company, but yes, with A&F specifically. We committed to sequential improvement, and that's what we have delivered. With a goal of approximately being flat for the fourth quarter. Janet Joseph Kloppenburg: Do you feel like the challenges that faced in merchandising in the first half at A&F are now behind you? Fran Horowitz: Yeah. We committed to getting clean. You know, the opportunities and first half, which we talked about on both of those calls, were really the opportunity that the inventory was much more balanced between sale clearance and regular price. That was something that we didn't really have in 2024. That's what drove the reduced AUR. As Robert mentioned, we've made sequential improvement in the AUR as we continue to see the customer responding to the newer product. Operator: Thank you. There are no further questions at this time. I'd like to turn the call back over to Fran for any closing remarks. Fran Horowitz: All right. Thanks, everyone. Just wishing you all a happy holiday season, and we look forward to updating you soon. Operator: Thank you for your participation. You may now disconnect. Everyone, have a great day.
Operator: Good day, ladies and gentlemen. Thank you for standing by, and welcome to Jiayin Group Inc.'s Third Quarter 2025 Earnings Conference Call. Currently, all participants are in listen-only mode. Later, we will conduct a question and answer session and instructions will follow at that time. As a reminder, we are recording today's call. If you have any objections, you may disconnect at this time. I will now turn the call over to Mr. Sam Lee from Investor Relations of Jiayin Group Inc. Please proceed. Sam Lee: Thank you, operator. Hello, everyone. Thank you all for joining us on today's conference call to discuss Jiayin Group Inc.'s financial results for 2025Q3. We released our earnings results earlier today. The press release is available on the company's website as well as from Newswire services. On the call with me today are Mr. Yan Dinggui, Chief Executive Officer, Mr. Chunlin Fan, Chief Financial Officer, and Ms. Yifang Xu, Chief Risk Officer. Before we continue, please note that today's discussion will contain forward-looking statements made under the Safe Harbor provisions of the U.S. Private Securities Litigation Reform Act of 1995. Forward-looking statements involve inherent risks and uncertainties. As such, the company's actual results may be materially different from the expectations expressed today. Further information regarding these and other risks and uncertainties is included in the company's public filing with the SEC. The company does not assume any obligation to update any forward-looking statements except as required under applicable law. Also, this call includes discussion of certain non-GAAP financial measures. Please refer to our earnings release, which contains a reconciliation of the non-GAAP financial measures to GAAP financial measures. Please note that unless otherwise stated, all figures mentioned during the conference call are in Chinese renminbi. With that, let me now turn the call over to our CEO, Mr. Yan Dinggui. Mr. Yan will deliver his remarks in Chinese. I will follow up with corresponding English translations. Please go ahead, Mr. Yan. Yan Dinggui: Good afternoon, everyone. Thank you for joining Jiayin Group Inc.'s Third Quarter 2025 Earnings Conference Call. In the third quarter, China's GDP grew by 4.8% year-on-year, slowing from 5.2% in the previous quarter but remaining stable overall. Consumption continued to play a dominant role, contributing 56.6% to growth. Meanwhile, demand for consumer finance has been rising steadily. A narrow consumer credit balance up 4.2% year-on-year as of September 30 signals from the recent regulatory policies indicate that coordinated efforts to stabilize growth, boost consumption, and advance inclusive finance are creating a favorable environment for our long-term healthy and sustainable development of the industry. In this quarter, the company facilitated RMB 32.2 billion in loan volume, a year-on-year increase of approximately 20.6%, and reported non-GAAP income from operation of RMB 190 million, up around 50.3% year-on-year, achieving our previously issued guidance. During the reporting period, the company maintained cooperation with 75 financial institutions, with another 64 under negotiation. We have been included in the white list by most of our partner financial institutions, providing a solid foundation for stable funding supply. Leveraging our technological strength, tropical management capabilities, and risk control expertise, we enhance our funding partners' capital allocation efficiency, accurately align with their risk preferences, and actively explore new models for business collaboration. Against the backdrop of industry contraction and tightening liquidity, we observed pressure on overall risk indicators and fluctuations in asset quality. In response, we rapidly iterated our risk control model, continuously tightened strategies for high-risk, high-volatility users, and introduced models combining long-term and short-term perspectives to enhance the flexibility and timeliness of risk monitoring, thereby enabling sharp insight into risk trends and enabling timely responses. At the end of the third quarter, the ninety-plus day delinquency rate stood at 1.33%. We will remain committed to prudent operations, continue to reinforce our competitive edge in risk management. To optimize resource allocation efficiency, we adopted a cautious strategy for new customer acquisition, with a stronger focus on high-quality borrower segments. All newly added channels are leading Internet platforms, and we continue to optimize our credit limit management to enhance user stickiness and facilitate repeat borrowing. Additionally, as the cornerstone of business growth, repeat borrowers saw their share of facilitation volume rise further to 78.6%. This drove the overall average borrowing amounts per borrowing up to RMB 9,115 yuan, representing a year-on-year increase of approximately 19.5%. Since the beginning of this year, the company's AI development has entered a new phase. Through increased resource investment and organizational restructuring, we have achieved multiple significant innovations, establishing a technical benchmark of high performance, low cost, and lightweight. In terms of deepening business empowerment, we focused on deploying multimodal anti-fraud systems and AI-powered agent assistance. Compared to external models, our in-house model not only directly reduces cost by over RMB 1 million but more importantly, builds our own technological moat while fundamentally enhancing our AI capability. By establishing a historical voiceprint database and a high-quality voiceprint processing pipeline, we conduct real-time fraud identification for incoming calls, identifying over 4,000 new fraudulent voiceprints to date. For image recognition, by capturing contextual features of applicants and screening clues from high-risk scenarios, we achieved an accuracy rate exceeding 90% in identifying associations with organized fraud. With the integration of these multimodal capabilities, the timeliness of fraud detection was compressed from a week to within two hours, forging a new tech-driven line of defense against fraud. In the customer service process, our AI product matrix covers the entire business process, from initial agent training and real-time conversation support to post-event analysis. With 100% agent coverage and over 90% accuracy, it significantly boosted staff efficiency and service quality. In terms of broadening business coverage, the launch of the intelligent agent R&D platform has significantly lowered the development threshold for AI agents. So far, the number of such agents has exceeded 300, with an internal monthly active penetration rate exceeding 40%, effectively enhancing department efficiency and enthusiasm in independently developing AI agents. The model management platform is dedicated to improving model deployment efficiency, reducing the time required for models to go from R&D to production from thirty-two days to sixteen days, and nearly tripling the number of models put into production. These two platforms have enabled various business departments to transition from stand-alone applications to an integrated collaborative ecosystem. Looking ahead, we will continue to further advance the four-plus-two strategy, focusing on four major application directions and leveraging two key infrastructure platforms to integrate existing AI models and tools, further achieving an upgrade and innovation from technological breakthrough to value creation. Overseas markets serve as both a game-changing engine for us to break through regional growth boundaries and a core pillar in building our global strategic footprint. In the third quarter, our Indonesian business maintained engagement with multiple financial institutions, driving business scale increased by nearly 200% year-on-year, and the number of borrowers rising by approximately 150% compared to the same period last year. Recognizing its growth potential, we have significantly increased our investment in the local operator, acquiring a stake of more than 20% through capital injection, demonstrating our strong commitment to local market development. In Mexico, the loan volume and user base have maintained rapid growth, with initial success in market expansion. Currently, we remain in a critical phase of product innovation and foundational capacity building, aiming to lay a solid foundation for in-depth local operation. With the implementation of the new loan facilitation regulation in October, the industry is undergoing numerous changes and challenges. The company projects its loan facilitation volume at RMB 23 billion to RMB 25 billion for Q4 2025, with full-year volume expected to be in the range of RMB 127.8 billion to RMB 129.8 billion, representing a year-on-year increase of approximately 26.8% to 28.8%. Full-year non-GAAP operating profit guidance is set at RMB 1.99 billion to RMB 2.06 billion, reflecting a growth of approximately 52.3% to 57.6%. Amid a complex, volatile, and increasingly competitive external environment, we aim to navigate cyclical headwinds with lean operational capabilities and forge long-term resilience for steady, sustainable growth. And with that, I will now turn the call over to our CFO, Mr. Chunlin Fan. Please go ahead. Chunlin Fan: Thank you, Mr. Yan, and hello, everyone, for joining our call today. I will now review our financial highlights for the quarter. Please note that all numbers will be in RMB. All percentage changes refer to year-over-year comparisons unless otherwise noted. As Mr. Yan noted earlier, we demonstrated robust business resilience in Q3 and successfully achieved our financial guidance. Loan facilitation volume was RMB 32.2 billion, representing an increase of 20.6% from the same period of 2024. Our net revenue was RMB 1.47 billion, representing an increase of 1.8% from the same period of 2024. Moving on to costs, facilitation and servicing expense was RMB 286.5 million, compared with RMB 419.1 million for the same period of 2024. This was primarily due to decreased expenses related to financial guarantee services. Allowance for uncollectible receivables, contract assets, loans receivable, and others was RMB 1.5 million, representing a decrease of 87.1% from the same period of 2024, primarily due to decreased allowance for overseas loans as a result of disposal of Nigerian entities during 2024 and the gross slowdown of receivables from loan facilitation business. Sales and marketing expense was RMB 544.2 million, representing a decrease of 1.1% from the same period of 2024. General and administrative expense was RMB 72.4 million, representing an increase of 29% from the same period of 2024, primarily driven by an increase in share-based compensation. R&D expense was RMB 108.7 million, representing an increase of 13.3% from the same period of 2024, primarily driven by an increase in expenditures for employee compensation-related benefits. Non-GAAP income from operation was RMB 490.6 million, compared with RMB 326.5 million in the same period of 2024. Consequently, our net income for the third quarter was RMB 370.765 million, representing an increase of 39.7% from the same period of 2024. Our basic and diluted net income per share was RMB 1.83, compared with RMB 1.27 in 2024. Basic and diluted net income for ADS was RMB 7.32, compared with RMB 5.08 in 2024. We ended this quarter with RMB 124.2 million in cash and cash equivalents, compared with RMB 316.2 million at the end of the previous quarter. With that, we can open the call for questions. Ms. Xu, our Chief Risk Officer, and I will answer your questions. Operator, please proceed. Operator: Thank you so much, dear participants. As a reminder, please standby while we compile the Q&A rules. This will take a few moments. And now we are going to take our first question. It comes from the line of Ivan Shu from Coergin Securities. Your line is open. Please ask your question. Ivan Shu: Good evening, management. Thank you for taking my questions. I am Yiwen from Synolink Securities. I have two questions. The first one is that after the new regulation took effect in October, what impact have you seen on the business? And could management provide more color on any strategic adjustments and the outlook going forward? This is my first question. Thank you. Yifang Xu: Hi, Yiwen. I will do the translation for Ms. Xu. So following the implementation of the new regulation, the impact on the industry has been pretty significant. Most of the changes have been primarily on the downward pressure of pricing and the continued emphasis on consumer protection. So as of October, the asset pricing of our loan facilitation business is fully compliant with the regulatory requirements of our funding partners. As liquidity tightened, we have responded to the pricing pressure and liquidity pressure in the broader industry and the volatility industry. We have really intensified adjustment traffic acquisition and placed a greater focus on cross-industry platforms and optimizing our traffic mix, adopting a more cautious customer acquisition strategy under the current environment. For our existing power base, we have enhanced borrower segmentation. On one hand, we want to improve our risk identification for higher-risk groups. We are utilizing measures such as managing outstanding balances and accelerating runoff based on indicators like recycle elasticity, pricing, and recent frequency to address the segments that are more challenging to operate under lower pricing. On the other hand, through product and pricing adjustments, we have strengthened the efforts to retain and reengage high-quality borrowers who may potentially churn. Taken together, these initiatives are helping us optimize the overall portfolio structure. Regarding asset pricing, it is foreseeable that the downward trend will continue. Our focus is not only navigating through the current period of volatility but also continuously strengthening our ability to operate through risk cycles over the long term. That is my answer for the first question. Ivan Shu: Thank you. And given the current environment, how should we think about the revenue take rate and the margin expectations going forward? Thank you. Chunlin Fan: Thank you, Yiwen. I will answer this question. In 2025, the company facilitated RMB 32.2 billion in volume and delivered RMB 491 million in non-GAAP income from operations, in line with the guidance we previously provided. The net profit for the quarter was RMB 376 million, representing a net margin of 25.6%. In terms of the net margin, it is a slight decrease from the 27.5% net margin in Q2. For the first three quarters, we achieved RMB 1.435 billion in net profit, up 84% year-over-year and already well above the full-year 2024 figure of RMB 1.056 billion. For the full year of 2025, we expect profitability to be significantly higher than 2024. As Ms. Xu mentioned, the new regulation brought short-term pressure to the industry while liquidity and asset quality. As a highly agile technology-driven company, and drawing on our past experience navigating regulatory credit cycles, we made timely and prudent adjustments to our business scale, risk posture, and pricing strategy in response to market conditions. Over the long term, enforcement of the new regulation will raise industry entry barriers and help drive the sector towards a healthier, more orderly, more compliant, and more sustainable development. As the industry shifts towards higher-quality borrower segments, pricing, therefore, revenue take rate is expected to moderate, and margins will return to a healthier and more sustainable level. The company is entering a new phase of high-quality development. I want to reiterate Mr. Yan's guidance that he provided earlier. We expect Q4 volume to reach RMB 23 to 25 billion, bringing full-year facilitation volume to RMB 127.8 to 129.8 billion, approximately 26.8% to 28.8% year-over-year growth. Full-year non-GAAP income from operation guidance is RMB 1.99 to 2.06 billion, approximately 52.3% to 57% growth year-over-year. Ivan Shu: Thank you, management. That is very helpful. No more questions. Thank you. Operator: Dear participants, if you would like to ask a question, please press 11 on your telephone keypad. Dear speakers, there are no further questions for today. I would now like to hand the conference over to Sam Lee for closing remarks. Sam Lee: Thank you, operator, and thank you all for participating on today's call. We appreciate your interest and look forward to reporting to you again next quarter on our progress. Operator: Thank you all again. This concludes the call. You may now disconnect.
Operator: Hello, ladies and gentlemen. Thank you for standing by, and welcome to Atour Lifestyle Holdings Limited third quarter 2025 Earnings Conference Call. At this time, all participants are in listen-only mode. After the speakers' presentation, there will be a Q&A session. Today's conference is being recorded. I would now like to turn the conference over to Mr. Luke Hu, Senior IR Manager. Please go ahead, sir. Luke Hu: Thank you, Operator. Good morning, and good evening, everyone. Welcome to our third quarter 2025 earnings conference call. Today, you will hear from our Founder, Chairman, and CEO, Mr. Haijun Wang, and our EVP, Co-CEO, Mr. Jianfeng Wu. Before we continue, please be aware that today's discussion will include forward-looking statements under federal securities laws. These statements are subject to various risks and uncertainties, and actual results may differ significantly from what is stated or implied in our comments today. The company is not obligated to update any forward-looking statements except as required by applicable laws. Additionally, during this call, our management will discuss certain non-GAAP financial measures solely for comparison purposes. For a clear understanding of these measures and a reconciliation of GAAP to non-GAAP financial results, please refer to the earnings release issued earlier today. Furthermore, a webcast replay of this conference call will be accessible on our website at ir.yadu.com, where a copy of the results presentation is also available. Now I will turn the call over to Mr. Wang, our CEO. Haijun Wang: Thank you, Luke. Hello, everyone. Thank you for joining Atour Lifestyle Holdings Limited's third quarter 2025 earnings call today. Amidst the ongoing volatility in the macro environment, consumers have shown a clear shift toward prioritizing value and making more rational purchasing decisions. Innovative experiences emerging from new scenarios and business models have become a key force driving the release of consumption potential. For the hotel sector, the overall market has shown a moderate recovery since the third quarter. While travel and leisure demand continues to be robust, the industry is also characterized by rapidly shifting hotspots and uneven recovery across regions. In the retail market, consumption is increasingly centered around experiential offerings and quality of life upgrades. Evolving consumer habits coupled with technological advancements are jointly fueling development across various segments. As a leading lifestyle group, Atour keenly observes the evolution of user needs and captures consumption trends with precision. Through continuous innovation and enhanced experience in both our hotel and retail businesses, we consistently respond to and lead contemporary consumers' pursuit of quality living. Now I would like to provide more details on our performance for 2025. Let's begin with our hotel business. Please turn to Slide four of our third quarter 2025 results presentation. In the third quarter, our RevPAR was RMB 371.3, representing 97.8% of its level in the same period of 2024. Specifically, OCC nearly recovered to the prior year level at 99.9% of the same period in 2024, and ADR reached 98.1% of its level in the same period of 2024. Please turn to Slide five. In the third quarter, RevPAR for our mature hotels in operation for more than eight months was 95% of the level in the same period of 2024, while OCC and ADR stood at 98.5% and 96.6% of their levels in the same period of 2024, respectively. Please turn to Slide six. Driven by our brand power and product excellence, Atour's hotel network steadily expanded with the successful launch of various high-quality projects. In the third quarter, we opened 152 new hotels, a record high for a single quarter. By the end of the third quarter, we had a total of 1,948 hotels in operation, representing a 27.1% year-over-year increase. We have full confidence in achieving our strategic target of 2,000 premier hotels by year-end, laying a solid foundation for the next phase of our journey. As of the end of the third quarter, our pipeline of hotels under development remained steady at 754. Amid our rapid expansion, we remain steadfast in our quality-first principle. By applying rigorous project selection criteria and strict quality standards, we are driving healthy and sustainable high-quality growth. Next, I would like to share the latest developments for our hotel brands. Please turn to Slide seven. Within our upper mid-scale product portfolio, ATURE 3.6 represents a new benchmark for ATURE series three hotels. To date, we have opened 19 3.6 hotels, which continue to gain market recognition and acclaim. Through meticulous attention to detail and optimized scenario design, ATURE 3.6 seamlessly integrates functional amenities, premium service, and humane ambience. It effectively addresses the core needs of guests for efficiency and comfort, offering a new, more refined choice for travel experiences. Please turn to Slide eight. Grounded in a forward-looking understanding of consumers' long-term needs, Atour Series four has received strong market recognition, reaffirming its precise product positioning. In the third quarter, the RevPAR of the Atour 4.0 hotels in operation for more than three months surpassed RMB 500, while delivering both functional utility and emotional value. Atour 4.0 hotels place greater emphasis on fostering a deep resonance with guests, creating a healing experience that promotes holistic well-being. The upper mid-scale segment has long been our core focus and strategic foundation. By leveraging the synergistic deployment of ATURE series three and Series four, we effectively serve the diverse needs of different customer groups. As Atour products continue to penetrate core business districts across cities, we will further solidify our competitive moat and leading position in the upper midscale market. Please turn to Slide nine. Saka Hotel represents a significant breakthrough for us in the upper-scale lifestyle segment. In the third quarter, the two operating hotels demonstrated robust performance, with RevPAR exceeding RMB 900. On November 18, our third Saka Hotel began its soft opening in Guangzhou and has already received positive market feedback. With its unique design style and exceptional accommodation experience, Saka Hotel continues to attract a diverse clientele, demonstrating its substantial growth potential. Saka Hotel is dedicated to creating rejuvenating journeys for the discerning clientele, masterfully fusing Eastern cultural heritage with modern aesthetics. We are now collaborating with a professional institution to integrate scientific wellness concepts across the guest experience, from customized healthy diets to carefully curated in-room amenities, building a comprehensive deep experience for guests and showcasing our thoughts and practice of the Chinese experience concept in the upscale segment. For our expansion strategy, we will continue to adhere to precise site selection, striving to make every Saka hotel a model of local lifestyle. Please turn to Slide 10. For our midscale brand, we consolidated our differentiated advantages by continuously refining our products, improving operational efficiency, and enhancing brand building. ATURE Lite continued its strong performance in the third quarter, with the RevPAR of ATURE Lite Series three hotels in operation surpassing year-ago levels. As the latest upgraded version, ATURE Lite 3.3 has seen its first batch of hotels successively open. 3.3 features a more mature model that incorporates targeted optimizations in practicality and spatial aesthetics, earning strong acclaim from both users and franchisees. At the current stage, ATURE Lite will continue to concentrate its presence in higher-tier cities, advancing steadily while building brand recognition through benchmark projects. Simultaneously, we are systematically enhancing our operational framework by refining service touchpoints, optimizing operational standards, and strengthening talent development. These efforts ensure premium experiences while consistently driving operational efficiency, solidifying our competitive edge in the midscale segment and laying a solid foundation for the long-term development of the ATURE Lite brand. Moving now to our retail business. Please turn to Slide 11. During the third quarter, our retail business sustained strong growth, with GMV reaching RMB 994 million, representing a 75.5% year-over-year increase. Online channels continue to contribute over 90% of total GMV. During the recently concluded Double Eleven Shopping Festival, Atour Planet has not only delivered its excellent sales momentum but has also further strengthened the DeepSleep brand image in the mind of users. Meanwhile, across both the third quarter and the Double Eleven period, Atour Planet also ranked among the top brands in the bedding category on major third-party platforms. Please turn to Slide 12. The outstanding performance of Atour Planet keeps validating our ability to provide comprehensive sleep solutions in the market. In our core categories, we pursue breakthrough innovation through initiatives like collaborative R&D with academic institutions, consolidating our competitive advantages while gradually expanding market reach. Meanwhile, based on in-depth insights into user needs, we are also developing new categories such as deep sleep fitted sheets and deep sleep loungewear, refining and enriching the sleep ecosystem of Atour Planet. Next, I will now walk you through the latest updates on Atour Planet's core categories. Please turn to Slide 13. In the third quarter, Atour Planet continued to lead the market in the pillow category across major third-party platforms. Deep Sleep Memory Foam Pillow Pro 3.0 has received glowing reviews for its excellent support and comfort. Since its launch, it has shown strong sales performance, exceeding RMB 100 million GMV in just 25 days, reducing 19 days compared to the previous generation. Up till now, the cumulative sales volume of the Deep Sleep Pillow Series has exceeded 8 million units since its release. In addition, we have expanded the Pillow portfolio with products like DeepSleep travel pillow and Deep Sleep Pillow for Children, gradually building a product portfolio that covers different scenarios and serves various user groups. This expansion demonstrates our execution capabilities in enhancing sleep experiences while reinforcing our category leadership position. Please turn to Slide 14. Atour Planet is leading the transformation of the category driven by the exceptional performance of our deep sleep thermal regulating comforter series. As the seasons change, we launched two upgraded products in the third quarter: DeepSleep Thermal Regulating Comforter Pro 2.0, all season and winter season, both featuring an upgraded dual-layer temperature control system that dynamically adjusts the sleep microenvironment for more stable rest. To date, the cumulative sales volume of the DeepSleep thermal regulating comforter series has exceeded 2 million units since its launch. Please turn to Slide 15. With the launch of new products targeting users' core sensory needs during sleep, we officially released the Atour Planet Deep Sleep Standard, covering the dynamic pressure stabilization factor for the pillow category and the dynamic temperature management factor for the comforter category. In the future, this standard will serve as the core criteria for product iteration, ensuring high quality and consistency of products. The establishment of this standard has also driven us to continuously enhance our supply chain capabilities, further strengthening our competitive advantages and the technical barriers in the sleep field. Our goal with this is to elevate industry standards and make natural deep sleep an experience that every user can truly perceive and achieve. In the current market where imitators and followers are emerging, Atour Planet remains committed to its founding aspiration, dedicated to listening to users' genuine needs and refining product details. Our deep understanding and agile responsiveness to user needs have become a solid moat, supporting long-term brand development. In the meantime, we will keep strengthening our foundational capabilities. We will pursue excellence in product development, supply chain management, and quality control to solidify a strong foundation for healthy growth. Looking to the future, we are ready to work with our industry partners to move forward together and guide China's sleep industry to a new stage of higher quality development. Please turn to Slide 16. Last but not least, I would like to share our progress across our membership business and channel development. With our growing brand influence and the continuous enrichment of our membership benefit system, our membership base maintained robust growth. By the end of the third quarter, the number of registered individual members exceeded 108 million, representing a year-over-year growth of over 30%. In terms of channel development, our core CRS channel remained stable, accounting for 62.4% of the total room nights sold in the third quarter. The contribution of room nights sold to corporate members was 20% during the quarter. Please turn to Slide 17. The evolution of the A-Card system and the upgrade of membership benefits stem from our deep understanding of members' genuine needs. By integrating online and offline resources, we have created multi-scenario end-to-end service experiences that continuously explore innovative possibilities in quality living. Looking ahead, we will sharpen A-Card's brand positioning. With a focus on a complete customer life cycle, we will analyze consumption patterns across accommodation and retail scenarios among different user groups, expanding lifestyle experiences and introducing compelling benefits and activities to deepen emotional connection with our members. Please turn to Slide 18. Moving forward, we will continue to deepen our focus across three key areas: user, employee, and fundamental capabilities. As for our users, we will always adhere to the user-first philosophy, embedding it across all touchpoints of our hotel and retail business. We will continuously enhance users' experiences and deepen our emotional connection with them. For our employees, we pay close attention to their growth trajectories and accumulated experience. Through diversified mechanisms, we redefine traditional industry promotion and development paths, driving continuous organizational evolution. To strengthen our foundational capabilities, we have been leveraging digital solutions alongside granular operations management, thus driving a comprehensive upgrade in both efficiency and the customer experience, providing a solid foundation for the group's long-term sustainable high-quality growth. I will now turn the call over to our Co-CFO, Mr. Jianfeng Wu, who will discuss our financial results. Jianfeng Wu: Thank you, Haijun. I would like to present the company's financial performance for 2025. Please turn to Slide 20 of the results presentation. Our net revenues for 2025 grew by 38.4% year over year and 6.5% quarter over quarter to RMB 2,628 million. Revenues from our monetized hotels for 2025 were RMB 1,560 million, up 32.3% year over year and 20.1% quarter over quarter. The year-over-year increase was primarily fueled by the ongoing expansion of our hotel network. The total number of our monetized hotels increased from 1,504 as of September 13, 2024, to 1,924 as of September 30, 2025. The quarter-over-quarter increase was mainly due to the growth in RevPAR and our supply chain business. Revenues contributed by our leased hotels for 2025 were RMB 164 million, representing a decrease of 13.4% year over year and an increase of 9.7% quarter over quarter. The year-over-year decline was primarily driven by a decrease in the number of leased hotels as a result of our product mix optimization. The quarter-over-quarter increase was mainly due to an increase in RevPAR. Revenues from our retail business for 2025 were RMB 846 million, reflecting a 76.4% year-over-year increase but a 12.3% quarter-over-quarter decline. The year-over-year growth was driven by increasing brand recognition, successful product innovation, and a broadened range of product offerings. The quarter-over-quarter decline was primarily due to the seasonality of our retail business. Now let's move to cost and expenses. Please turn to Slide 21. Hotel opening costs for 2025 increased by 23.5% year over year and 21.1% quarter over quarter to RMB 1,082 million. These increases were primarily due to higher variable costs, such as supply chain costs and hotel manager costs, associated with our ongoing hotel network expansion. Gross margin of our hotel businesses expanded to 37.3% in 2025, from 36% during the same period of 2024, primarily due to a lower proportion of leased hotels as the result of our product mix optimization. Retail costs for 2025 went up by 36.3% year over year and down by 11.2% quarter over quarter to RMB 100 million. The year-over-year increase was associated with the rapid growth of our retail business. Gross margin of our retail business remained stable compared to the same period of 2024. Now please turn to Slide 22. Selling and marketing expenses for 2025 were RMB 355 million compared with RMB 218 million for the same period of 2024. Selling and marketing expenses accounted for 13.5% of net revenues for 2025 compared with 11.5% for the same period of 2024. The increase was mainly due to investments in brand recognition and the effective development of online channels, in line with the growth of our retail business. General and administrative expenses for 2025 were RMB 100 million and included RMB 10 million in share-based compensation expenses, compared with RMB 82 million for the same period of 2024, which also included RMB 3 million in share-based compensation expenses. General and administrative expenses, excluding share-based compensation expenses, accounted for 3.4% of net revenues for 2025, compared with 4.2% for the same period of 2024. The decrease was primarily due to improved management efficiency and economies of scale. Technology and development expenses for 2025 were RMB 44 million compared with RMB 30 million for the same period of 2024. Technology and development expenses accounted for 1.7% of net revenues for 2025 compared with 1.6% for the same period of 2024. Please turn to Slide 23. Adjusted net income for 2025 was RMB 488 million, representing a 27% increase year over year. Adjusted net profit margin for 2025 was 18.6%. Adjusted EBITDA for 2025 was RMB 685 million, up by 28.7% year over year. Adjusted EBITDA margin for 2025 was 26.1%. Please turn to Slide 24. We also maintained a healthy cash position. As of September 13, 2025, our cash and cash equivalents totaled RMB 2,670 million with net cash of RMB 2,603 million. Please turn to Slide 25. In line with our commitment to enhancing shareholder value and our annual dividend policy adopted in August 2024, today, we declare our second cash dividend for 2025, totaling approximately USD 50 million. Through a comprehensive shareholder return initiative encompassing dividends and share repurchase, we are taking concrete actions to reward shareholders' trust and support, enabling all shareholders to share in the company's growth achievements. Please turn to Slide 26. For the full year 2025, given ongoing network expansion and rapid growth of our retail business, we currently expect total net revenues to increase by 35% compared with the full year 2024. That concludes our financial highlights for 2025. Now let's open for Q&A. Operator: Thank you, management. We will now begin the question and answer session. To ask a question, please wait for your name to be announced. For the benefit of all participants on today's call, if you raise your questions in Chinese, please immediately repeat your questions in English. Please limit your questions to one at a time. If you wish to have follow-up questions, please rejoin the queue. One moment for the first question. Our first question comes from the line of Dan Chi from Morgan Stanley. Please go ahead. Dan Chi: Hello, management. Could the management share the RevPAR trend since October? And also, if it's possible, can you provide your outlook for RevPAR in the fourth quarter and also potentially next year? Thank you. Haijun Wang: Thank you, Dan. Let me address your question. Since the beginning of this year, with the continued recovery in industry supply and demand dynamics, we have adhered to high-quality development and leveraged a refined strategy of revenue management, demonstrating strong operational resilience. Throughout the first three quarters of this year, our RevPAR has shown a trend of progressive improvement on a year-over-year basis. During the National Day holiday, leisure travel demand remained robust, but the market exhibited some significant structural divergence. Driven by stronger ADR, our RevPAR achieved year-on-year growth. After the holiday, the market returned to a business-dominated environment. But benefiting from active exhibitions and business travel activities, the demand in core cities demonstrated strong resilience. Therefore, we expect the pressure from the year-on-year decline in RevPAR to further ease in the fourth quarter. Looking ahead, the market will continue to show divergence, with still some challenges and uncertainties remaining. We will continue to deeply understand user needs, strengthen our foundational capabilities, and attract users with high-quality hotel products and differentiated experiences. By forging deeper emotional ties with them, we will secure long-term advantages in a volatile market environment and demonstrate our resilience for development. Thank you. Dan Chi: Thank you, Haijun. Next question, please. Operator: Thank you for the question. Next question comes from Sijie Lin of CICC. Please go ahead. Sijie Lin: Thank you, management. Could you please share more about the recent new hotel signing trends and whether there are any changes to the full-year hotel opening and closure targets? Thank you. Haijun Wang: Thank you, Sijie. Let me answer your question. In recent years, we found that during our scale expansion, Atour Lifestyle Holdings Limited has consistently maintained our strategic focus on premier hotels, concentrating on core locations for expansion, and we strictly controlled quality. At the same time, we have launched several new hotel products that align with market needs. With the successful launch of many high-quality projects, our brand strength and differentiated competitive advantage have been further solidified. So we do not endorse a growth strategy driven purely by scale. We firmly believe that only by advancing scale growth on the foundation of quality can we achieve sustainable betterment. Regarding signings, as we mentioned earlier, we maintain a strict selection mechanism, focusing on expansion in core business districts of key cities. With high quality being a prerequisite, the total number of new hotel signings this year is generally in line with last year, maintaining a steady development pace. At the same time, we are also clearing stock projects in the pipeline in an orderly fashion to promote the healthy development of our pipeline. In terms of openings and closures, we opened 152 hotels in the third quarter. We have full confidence in achieving the full-year guidance of 500 new openings and reaching our strategic target of 2,000 premier hotels by the end of this year. Meanwhile, for the operating hotels of ours, we place great emphasis on operational quality and user experience. By strengthening standard implementation and refined management, we can ensure that every hotel can deliver consistently high-quality service. To this end, we maintain a certain proactive replacement rate to continuously enhance the quality of our overall hotel network. In the third quarter, we closed 28 hotels and expect approximately 80 closures entirely for this year. Thank you. Sijie Lin: Thank you, Haijun. Next question, please. Operator: Thank you for the question. Next question comes from Xin Chen of UBS. Please go ahead. Xin Chen: This is Xin Chen from UBS. My question is about the retail business. Could the management share your perspective on the competition in the retail business? In addition, given the consistent performance of the retail business, would you consider any adjustments to your full-year retail revenue guidance? Thanks. Haijun Wang: Thank you, Xin Chen. Let me start by sharing the development strategy of ours and the competitive landscape of our retail business. Since Atour Planet entered the sleep industry, our brand and product power have gradually gained market recognition. This has been followed by a rise in imitators and industry participants, leading to increasingly fierce competition. However, we always believe that the real competition is not about the peers but is about the ever-evolving user needs. To address this, we did not simply follow the existing industry path. Instead, we progressively built our products and supply chain system with our distinctive characteristics. For example, we officially launched the Atour Planet Deep Sleep Standard recently. This standard differs from traditional industry metrics like fabric weights or thread counts, but it is based on sensory science and the natural rhythms of human sleep, focusing on two core sensory indicators of sleeping users: the fluctuation of pressure and the change of temperature. This standard also places higher demands on our product development and production. We aim to continuously strengthen our product barriers through this forward-looking standard while collaborating with the upstream supplier partners to jointly lead the industry progresses. As a relatively new player in the industry, we always plan our layout with a longer-term mindset. While developing quite rapidly, we have been constantly building our foundational capabilities. I believe our underlying philosophy is consistent between the retail and hotel businesses, which is to always prioritize quality over scale. Moving forward, Atour Planet will continue to strengthen our product power, remain user-centric, focus on the systematic development of our long-term capabilities, and practice Atour Lifestyle Holdings Limited's long-termism development path. Let me address your question about our retail revenue. During the Double Eleven period, Atour Planet delivered outstanding performance and continuously strengthened our brand presence in the minds of users. Based upon our strong performance in Q3 and the Double Eleven, we are now raising our full-year retail revenue growth outlook to at least 65% year on year and accordingly adjust the group's full-year revenue guidance to a growth of 35% year on year. Thank you. Xin Chen: Thank you, Haijun. Next question, please. Operator: Certainly. Next question comes from Ronald Leung of Bank of America. Please go ahead. Ronald Leung: Let me translate my question into English. So we noticed Atour Lifestyle Holdings Limited has announced a second dividend distribution plan this year. Could management provide an update on the planning and progress regarding shareholder returns? Thank you. Haijun Wang: Thank you, Ronald. Regarding dividends, as we announced today, our second dividend distribution this year amounts to approximately USD 50 million, representing about 29% of last year's net income. Consequently, the cumulative dividend total for this year reaches about USD 100 million, accounting for approximately 2% of the prior fiscal year's net income, exceeding our commitment of no less than 50% of that. Additionally, we formally commenced our share repurchase program in September and will continue to execute them in accordance with our established three-year plan. Looking ahead, we will continue to implement our comprehensive shareholder return program, combining dividends and repurchases, targeting a payout ratio of 100% based upon the previous fiscal year's GAAP net income, with the specific implementation pace to be dynamically arranged in line with our business development and capital planning. Through these tangible actions, we are committed to creating long-term value and sharing the success of the company with our shareholders, in appreciation of your ongoing support and trust. Thank you, Ronald. Next question, please. Operator: One moment for the next question. The next question comes from Lydia Ling of Citi. Please go ahead. Lydia Ling: Thank you, management. I'm Lydia from Citi. We noticed the strong operational performance for Atour Lite in the third quarter. Could you share your plan for Atour Lite in the next step? And any plan for accelerating the store expansion? Thank you. Haijun Wang: Thank you, Lydia. Yes, indeed. In the third quarter, the RevPAR of operating Atour Lite Series three hotels surpassed the level from the same period last year, performing pretty decently. In fact, since the beginning of this year, Atour Lite has achieved notable results in brand building, operational efficiency, and user experience, with both operational performance and scale growth meeting our expectations. We always believe that the core of a brand license is products. The Atour Lite hotel product accurately aligns with the needs and aesthetic preferences of today's young users. The newly launched Atour Lite 3.3, with its constantly optimized investment model, achieved a better balance between service experience and operational efficiency. Through the implementation of the first batch of our Atour Lite 3.3 project, we are constantly gathering feedback from various sites, refining product details, and strengthening our differentiated competitive advantage in the midscale market. We expect the scale of Atour Lite Series three hotels in operation will be reaching 170 to 180 by the end of this year. We are firmly optimistic about the long-term development of Atour Lite. At this current early stage of the brand development, we are particularly focused on solidifying the operational foundation and our systematic capabilities. As for our next step, we will systematically build a dedicated operational system for Atour Lite, strengthening its differentiated positioning in all aspects, including from brand concept to service delivery. This will not only distinguish it from our main Atour Hotel brand but also highlight the unique value in the midscale hotel market. On this basis, we will steadily advance towards a longer-term development goal of hitting the 1,000 hotels milestone for the Atour Lite brand. Thank you. Lydia Ling: Thank you, Haijun. Operator: That concludes today's question and answer session. I would like to turn the conference back to Mr. Luke Hu for any additional comments or closing comments. Luke Hu: Thank you for joining us today. If you have any further questions, please feel free to contact our IR team. We look forward to speaking with you again next quarter. Thank you, and goodbye. Operator: This concludes today's conference call. Thank you for participating. You may now disconnect.
Operator: Hello, ladies and gentlemen. Thank you for standing by for NIO Inc. Third Quarter 2025 Earnings Conference Call. At this time, all participants are in a listen-only mode. Today's conference call is being recorded. I will now turn the call over to your host, Rui Chen, head of investor relations and corporate finance of the company. Please go ahead, Rui. Rui Chen: Good morning, and good evening, everyone. Welcome to NIO's Third Quarter 2025 Earnings Conference Call. The company's financial and operating results posted on the company's IR website were published in the press release earlier today. On today's call, we have William Li, Founder, Chairman of the Board, and Chief Executive Officer, and Stanley Qu, Chief Financial Officer. Before we continue, please be kindly reminded that today's discussion will contain forward-looking statements made under the safe harbor provisions of The US Private Securities Litigation Reform Act of 1995. Forward-looking statements involve inherent risks and uncertainties. As such, the company's actual results may be materially different from the views expressed today. Further information regarding risks and uncertainties is included in certain filings of the company with the US Securities and Exchange Commission, the Stock Exchange of Hong Kong Limited, and the Singapore Exchange Securities Trading Limited. The company does not assume any obligation to update any forward-looking statements except as required under applicable law. Please also note that NIO's earnings press release and this conference call may include discussions of unaudited GAAP financial information as well as unaudited non-GAAP financial measures. Please refer to NIO's press release, which contains a reconciliation of unaudited non-GAAP measures to comparable GAAP measures. With that, I will now turn the call over to our CEO, William Li. William, please go ahead. William Li: Hello, everyone, and thank you for joining NIO's 2025 Q3 earnings call. In Q3 2025, the company delivered 87,071 smart EVs, representing a year-over-year growth of 40.8%. During the quarter, we launched two large zero battery electric SUVs, the Omo L90 and the new Omo ES8. Both models have received strong recommendations from users for their comprehensive competitiveness and continue to see solid demand. In the meantime, Firefly continued to see steady market growth and meeting more diverse needs by covering a broader range of price segments. The new Envo and the Firefly brands are able to drive significant growth in deliveries. In October, the company delivered 40,397 smart EVs, up 92.6% year-over-year, marking three consecutive months of record-high delivery. For Q4, we expect total deliveries to be in the range of 120,000 to 125,000, a year-over-year increase of 60.1% to 72%, achieving a new quarterly high. On the financial front, thanks to the ongoing cost optimization, in Q3, the vehicle gross margin improved to 14.7%, and the gross margin of other sales was 7.8%, resulting in an overall gross margin of 13.9%, the highest in nearly three years. This reflects the company's strengthened product and service profitability. Operational efficiency in R&D, sales, and general administration continued to improve. Non-GAAP operating loss was narrowed by 30% quarter over quarter. In Q3, the company's operating cash flow and free cash flow both turned positive. NIO remains committed to the battery electric vehicle roadmap featuring chargeable, swappable, and upgradable batteries. Leveraging the company's full-stack R&D capabilities in 12 key tech areas, the third brands are able to precisely meet users' needs across multiple market segments. The competitiveness of our new products under all their brands has been well received. The new brand recently introduced three color themes for the ET9 Horizon edition. The Horizon edition is a special collection reserved for NIO's most prominent flagship models. The distinctive design, advanced technology, executive excellence, and exclusive services make the ET9 Horizon edition a standout in the market. The all-new ES8, an all-around tech flagship SUV, was launched and started delivery at NIO Day in September. Leveraging the unrivaled space and driving experiences made possible by all-electric technology, the all-new ES8 has remained a top seller in the premium large zero SUV segment, surpassing 10,000 deliveries within just 41 days, the fastest for a price above 400,000 RMB. In November, the ES6, another all-around SUV in NIO's lineup, celebrated its 300,000 unit delivery milestone, topping the sales chart of China's fabs model twice over 300,000 RMB. Within the Amo brand, the L90 delivered over 33,000 units in three months since its launch in late July, leading the large battery electric SUV segment for three consecutive months. The L60 also delivered strong performance, maintaining a top two position in the battery electric SUV segment with MSRP above 200,000 RMB during the first March. With exceptional products, experiences, and word-of-mouth, the Amo brand increasingly becomes the preferred choice for families. Since delivery began, Firefly has led the high-end small EV market in sales volume, establishing itself as a benchmark in the market. With creative launches of special editions, it continues to strengthen its appeal among users who value quality and individuality. This dynamic small car is already making its way into the global market and will expand into more countries and regions across Europe and Asia. In smart driving, the new world model, NWM, is the first world model that not only understands and predicts the real world but also operates with a closed-loop training system. Actually, the industry trend is increasingly toward a work model roadmap. Next, we will gradually roll out upgrades on NWM for vehicles equipped with NIO's NX90 31 and Amelia's O ring X smart driving chips, further enhancing urban and highway NOP plus, parking, and smart safety performance. The upgrade will also enable execution of open set command. For the on-road smart driving, the Coconut 210 scheduled for release at year-end will upgrade its model-based end-to-end solution for urban and highway NOA, as well as parking, delivering a more seamless driving experience. Our self and service network currently includes 172 NIO houses, 395 NIO spaces, 422 Amo stores, as well as 405 service centers, and 70 delivery centers. Our global charging and swapping network now operates 3,641 power swap stations, providing users with more than 92 million swaps. Besides, NIO has built over 27,000 power chargers and destination chargers. On September 17, NIO completed a total of $1.16 billion in equity financing on both the US and Hong Kong stock exchanges, further strengthening its balance sheet and providing ample resources for its long-term commitment to R&D and user services. On November 23, the 2025 NIO Cup Formula Student Electric China successfully concluded in course A. NIO has been supporting this competition since 2015, helping cultivate tens of thousands of young professionals for the industry. Today also marks the company's eleventh anniversary. Over the past eleven years, we have remained committed to in-house R&D in core smart EV technologies, continued investing in charging and swapping infrastructure, built a multi-brand sales and service system, and created a vibrant community for over 900,000 users to share joy and grow together. These advantages have been increasingly recognized by our users. This year, our new products across three brands have performed strongly in their respective market segments, marking the beginning of a new phase of rapid growth. At the same time, through the cell business unit mechanism, we have comprehensively optimized our organization and enhanced operational efficiency, consistently improving our business rooted deep and growing beyond. Looking ahead, we will continue to provide more competitive technology products and services to deliver better user experience and greater user value. As the company evolves into a user enterprise, leading in technology and experience, we aim to shape a sustainable and brighter future with more users. Thank you for your support. With that, I will now turn the call over to Stanley for Q3 financial details. Over to you, Stanley. Stanley Qu: Thank you, William. Let's now review our key financial results. For 2025, average total revenues reached 21.8 billion RMB, increased 60.7% year over year and 14.7% quarter over quarter. Vehicle sales were 19.2 billion RMB, up 15% year over year and 19% quarter over quarter. The year-over-year growth was mainly due to higher deliveries, partially offset by lower average selling price from product mix changes. The quarter-over-quarter increase was mainly from higher deliveries. Other sales were 6.226 billion RMB, up 31.2% year over year and down 9.8% quarter over quarter. Year-over-year growth was driven by increased sales of used cars, technical R&D services, and sales of car accessories, and after-sales vehicle services. While the quarter-over-quarter decrease was mainly due to the decrease in revenues from used cars technical R&D services, partially offset by the increase in parts accessories, and after-sales vehicle services and provision of power solutions. Looking at margin, vehicle margin was 14.7%, compared with 13.1% in Q3 last year and 10.3% last quarter. The year-over-year and the quarter-over-quarter increase were mainly due to the decreased material cost per unit primarily driven by our comprehensive cost reduction efforts. Overall, gross margin was 13.9%, versus 10.7% in Q3 last year, and 10% last quarter. The year-over-year increase mainly reflected higher vehicle margin and better profitability in sales of parts, accessories, and after-sales vehicle services, driven by cost reduction and efficiency improvements. The quarter-over-quarter increase was mainly attributable to higher vehicle margin. Turning to OpEx, R&D expenses were 2.4 billion RMB, decreased 28% year over year and 20.5% quarter over quarter. The decrease year over year and quarter over quarter were mainly driven by lower personnel costs in R&D functions due to organizational optimization and decreased design and development costs from different development stages. SG&A expenses were 4.2 billion RMB, up 1.8% year over year and 5.5% quarter over quarter. Year over year, SG&A expenses stayed stable. The quarter-over-quarter increase was mainly driven by the increase in sales and marketing activities associated with new product launches. Loss from operations was 3.5 billion RMB, down 32.8% year over year and 28.3% quarter over quarter. Excluding share-based compensation expenses and organizational optimization charges, adjusted loss from operations was 2.83 billion RMB, representing a decrease of 39.5% year over year and 31.3% quarter over quarter. Net loss was 3.5 billion RMB, showing a decrease of 31.2% year over year and a decrease of 30.3% quarter over quarter. Excluding share-based compensation expenses and organizational optimization charges, adjusted net loss was 2.7 billion RMB, representing a decrease of 38% year over year and 33.7% quarter over quarter. Furthermore, we generated positive operating cash flow and positive free cash flow this quarter, together with the $1.16 billion US dollar equity offering in September. We ended the quarter with 36.7 billion RMB in total cash and cash equivalents, restricted cash, short-term investments, and long-term time deposits, laying a solid foundation for our future growth. That wraps up our prepared remarks. For more information and the details of our unaudited third quarter 2025 financial results, please refer to our earnings press release. Now I will turn the call over to the operator to start our Q&A session. Operator? Operator: Thank you. If you wish to ask a question, please press 1 on your phone and wait for your name to be announced. If you wish to cancel your request, please press 2. If you are on a speakerphone, please pick up the handset to ask a question. For the benefit of all the participants on today's call, please limit yourself to two questions. And if you have additional questions, you can reenter the queue. Our first question comes from the line of Tim Hsiao from Morgan Stanley. Please go ahead. Tim Hsiao: Hi. Thanks for taking my question. This is Tim from Morgan Stanley. So I have two questions. The first question is about a breakeven target because we noticed that NIO's updated fourth quarter delivery guidance of 120,000 to 125,000 came in around 20% lower than our previous target of 150,000. Just wondering if there was a volume shortfall adversely affecting the company's breakeven target for the fourth quarter. And considering the sub-seasonal demand and positive uncertainty, when could the company achieve the previous monthly ROE of 50,000? That's my first question. William Li: Thank you for the question. Actually, for the company, we still have the confidence in achieving quarterly breakeven in Q4, and this is still our financial target towards the end of the year. But in the meantime, we did see the impact coming from the phase-out and the termination of the trade-in and replacement subsidies since October. But this is actually the challenge faced by the entire industry. In that case, in Q4 for the entire industry, we may not see the year-end sales spike that we normally expect towards the end of the year. As you are closely tracking the market and all the numbers, probably you have also foreseen that potential change towards the end of the year. And in the meantime, as next year, the purchase tax exemptions on the new energy vehicles will be further reduced for the new products like the ES8 with order backlog that will continue towards the next year. Car companies, including NIO, provide the guarantee for the purchasing tax exemptions to users waiting up for their cars next year. Yet no car company is going to provide the guarantee for the trade-in and replacement subsidy. In that case, the overall market demand has been affected because of the cancellation of the trade-in subsidy. Especially for our company, our Amo L60 and L90 are majorly affected by this cancellation as they are also relatively low price segment and are more sensitive to such changes. Yet we still have confidence in achieving the Q4 breakeven target. This is mainly because we do see a strong demand for our high-margin products like the all-new ES8. We still have ample order backlog and also new order intake for that product. So overall speaking, the order intake on the Amo has been affected because of the cancellation of the trade-in subsidy, yet the overall impact on the gross profit is limited. In that case, we do have the confidence for the financial targets. In the meantime, in terms of the vehicle gross margin, in Q3, we have achieved the vehicle gross margin of 14.7%, better than we expected. In the meantime, we are also working with our supply chain partners on the continuous cost reduction and also commercial negotiation efforts towards Q4. With that, we foresee the vehicle gross margin in Q4 to be around 18%. And for the ES8 in Q4, we also expect significant growth in sales and the delivery volume with a very lucrative margin of over 20%, then the overall gross profit for the entire company will be significantly improved from Q3. In the meantime, we also see good financial performance of our non-car sales business, and we also expect such momentum to continue into Q4. So we see improvements both in the sales revenue contributed by the non-vehicle business as well as the gross margin improvement of that part. With that, the gross profit, the vehicle gross profit, or the non-vehicle gross profit will also see improvement from Q3 to Q4. And in terms of the expense and also cost control, since this year, we've been taking a series of actions in improving our operational efficiency and our expenses utilization. And we already see some good results from the Q3 financials. And we will also continue such effort in Q4 in improving the sales SG&A expenses as well as the R&D expenses and their efficiency. Especially in Q4, we don't expect any major or high-profile marketing or campaigns. In that case, we will be controlling our expenses in Q4 with our SG&A as well as the R&D. So to sum up, our sales volume was affected by the phase-out of the trade-in and replacement subsidy, yet the gross profit is not majorly affected. In the meantime, we will continue our efforts in improving the efficiency and utilization of our investment and expenses. In that case, we expect also improved business results from Q4 and also have the confidence in achieving the quarterly breakeven target. Tim Hsiao: Thank you, William, for all the details. My second question is about our volume targets, together with the new model schedule. Because I think back to previous quarters, the management mentions that we target, like, 50,000 monthly run rate in the fourth quarter. So if we are not going to achieve that, when can we achieve 50,000 monthly sales? And considering all the macro uncertainties, will NIO need to consider moving up the launch schedule of the new models to the first quarter or earlier to bolster the sales momentum into next year? That's my second question. Thank you. William Li: Thank you for the question. As also previously mentioned in my remark, the guidance we provide for Q4 is 120,000 to 125,000 units. In terms of the adjustment on the guidance, as also explained, it's mainly because of the impact on the phase-out of the trade-in and replacement subsidy. With that, we will not be able to see the year-end sales spike driven by the seasonality towards the end of the year, especially this will affect the sales of our cars that have already experienced their new car hype stage. But this is also the challenge faced by the entire industry. Based on our current product lineup and also launch cadence, we do expect that sometime next year, in the 50,000 monthly delivery. This is based on the consideration that we will be launching three large models next year and also based on the continuous improvement in our cell capacity and also our sales and marketing efficiency. So we do see the opportunity of achieving more than 50,000 units per month somewhere in the first half of next year. And in the meantime, we will also not just randomly change our new car launch cadence or plan simply because of short-term or temporary policy changes or impact. We will still keep our original launch cadence, that is to launch two new models in Q2 next year and one new model in Q3 next year. Tim Hsiao: Thanks. Thank you, William and Stanley. Looking forward to the first breakeven quarter and more to come. Operator: Thank you. Your next question comes from Paul Gong with UBS. Please go ahead. Paul Gong: Hi, William. Thanks for taking my question. My first question is regarding the 2026 outlook. Given there would be 5% of the purchase tax being levied on the EVs, how shall we think about the company's preparation for such a policy change? Or shall we compensate for the customers for this amount and adjust it along the supply chain and internal cost control? Or do we expect to let the consumers take the majority of the ads? This is my first question. William Li: Thank you for the question. As next year, the purchasing tax on the new energy vehicles will be halved. Actually, the impact on us is less major in comparison to other new energy vehicle models and also companies. As 80-90% of our users choose to buy the car while subscribing to the battery. In that case, the price of the battery is excluded from the tax base. In that case, our tax exemption is still more advantageous than other companies and also non-swappable models. And in the meantime, for the popular products like the Allian ES8 with very long waiting time for the deliveries and pickup, we are also the first car company to announce the purchasing tax guarantee for our users who have to pick up their cars next year. We have made this purchasing tax guarantee already at the launch of the ES8. For other products and models, as their waiting time is not as long as on the ES8, so far, we don't have the guarantee policy for other models. As for the specific measures that we are going to take in the face of the purchasing tax changes next year, well, it highly depends on the dynamics of the market, the landscape of the competition, and also the practices of other peers. So we will keep flexibility in our measures and also policies. But currently, we don't have a very specific plan. And in the meantime, we also see that the entire industry, including the public and users, are gradually digesting the phase-out of the purchasing tax policies on the new energy vehicles. Especially right now, if we look at the smart EV industry in China, it is now less policy-driven. As the actual user experience and also the cost advantage of battery electric vehicles are more evident and also becoming more attractive to the users. In the first ten months of this year, the sales volume growth of the app actually increased significantly. This also gave us the confidence in continuing such momentum. So there will be an impact from the purchasing tax phase-out, but it will be very limited. Paul Gong: My second question is regarding the expense control. And we have already seen quite some cost reduction, especially from the R&D in Q3. And per your guidance, Q4 should see further efficiency improvement there. Heading to 2026, shall we expect the lower cost structure on the expense side to stay as a constant and new normal? Shall we expect, like, low 2 billion something for the R&D per quarter? Around 4 billion or even lower than 4 billion on the SG&A per quarter? William Li: Thank you for the question. As mentioned, in Q3, our R&D expenses are around 2 billion RMB on a non-GAAP basis. And also for Q4 and the next year, we expect our quarterly R&D expenses to be flat, also around 2 billion per quarter. And so far, we don't have any plan to dial back on the R&D expenses. But in the meantime, we will focus more on improving the efficiency of our R&D activities, especially leveraging our self-business unit mechanism. We will make full use of the output of this 2 billion R&D investment every quarter inside the company for the project initiation and approval. We have established the ROI evaluation mechanism. We also have the closed loop with the project review and also improvement. By continuing such efforts, we believe that at RMB 2 billion per quarter in R&D, we will be maintaining our existing product development as well as the key technology development without compromising on the competitiveness of the entire company. And in terms of the SG&A expenses and its percentage to the sales revenue, as in Q4, based on the sales volume guidance, we have lowered our volume from 50,000 units per month. In that case, originally, our target is to achieve a 10% ratio between SG&A and the sales revenue, and now it's around 12%. And in Q4, we will also be keeping that level, but this is against the overall background of achieving the quarterly breakeven in Q4. And in terms of the absolute amount, that's around 4 billion per quarter, as you mentioned. And next year, we will focus on improving our efficiency in sales and also overall activities. Overall, we believe that 10% between SG&A to the total sales revenue should be a winnable target for us to achieve. Paul Gong: Thank you, William and Stanley. Looking forward to more efficient operation going forward. Operator: Thank you. Your next question comes from Nick Lai with JPMorgan. Please go ahead. Nick Lai: Yes. This is Nick from JPMorgan. Thank you for taking my question. The first question is actually regarding the possibility into 2026. Based on William's comment earlier, now from the second quarter of next year, we have three new models and monthly sales reaching 50,000 units. And William also mentioned that this expense ratio of expense should be compared. So with all these comments, is it fair to say that the second quarter of 2025 breakeven and then next year, for the full year or at least the second half of next year, likely, you know, profitability should also be very strong? That's my first question. How should we think about profitability in 2026? William Li: Thank you for the question. Actually, for the full year, our business target is to achieve profit for the full year 2026 on a non-GAAP basis. And we do see confidence in achieving this profitability target for next year. Non-GAAP, as we basically look at this from both market trend as well as the relative competitiveness of our product and services. Here are some insights into the trend over the past one year or so. We will be really looking at the penetration rate of the battery electric vehicle in the premium segment and also most specifically in the large railroad SUV market. In Q3, the sales volume of the fab increased by 26% quarter over quarter, while for RIV and TEAHIVE, the sales volume only increased by 127%. Well, actually decreased by 127% quarter over quarter. And if we look at the entire new energy vehicle market, the penetration rate has reached 55% in Q3, and this is majorly powered by the growth in the battery electric vehicle. And in the first three quarters, the sales volume of the bypass increased by 33%, while for rib, it's only 3%. And more specifically in October, the BAV sales volume increased by 13% while for the rib, it decreased by 13%. So this is also showing how well received and adopted the BAV model is. And more specifically, on the premium segment, price above 300,000 RMB, this is where our new brand and our products are in. For the past, it's still at a relatively low penetration rate, but we do see a trend of improving that penetration. This also gives a huge opportunity for enlarging our penetration and market share in that segment. For this year, especially, we see the trend where the premium battery electric vehicle products are more and more received by the users. We have already seen the awareness and also the appetite for such products. And, also, this has powered the increase in the penetration rate of this product. For the full year last year, the penetration rate of the battery electric vehicle in the premium segment was only 12%. But in 318%, and in the first three quarters, the penetration rate of the fab has increased by 33%. Yet for the range-extended vehicle, it actually decreased by 10%. And more specifically, for the large railroad SUV segment, the sales volume of the bus took the first place for the first time in September, and it continued such momentum in October. In October, we see the total volume of the fab registration was around 39,000 units. Well, for RIB, that was only 24,000 units. Regarding the sales volume and also for next year, as for the OA L90 and also the new OA ES8 next year, we will still continue the bus around these two new products relatively new to the market. Plus, we are going to introduce another three new large models. So we will be having five new large models available to the market next year from the new and Amo brand. And if we look at the mid to large and also the large SUV segments where our new models will be targeting, in Q3, the sales volume of fab models increased by 140%. Well, for WIP, it's only 19%. But as mentioned, the overall penetration rate of a bath among the premium largest vehicle models, it's still relatively low, which means that we do have huge opportunities and potential in this segment. So overall speaking, our product launch cadence is in line with the market shift and also the trend, especially considering our large models are also competitive in both products as well as the charging and swapping experience. And, also, for these five large models, they will also contribute the major sales volume among all of our products. As they are high-margin products, they will also contribute more significantly to the vehicle gross margin. With that, next year, we expect the vehicle gross margin to be around 20%. That is the further improvement on top of our existing gross margin for Q3 and also outlook for Q4. But, also, this result will be dependent also on the continuous cost optimization efforts together with our supply chain partners. And in terms of the expenses, as we rolled out this cell business unit mechanism, we have tightened our control over expenses. We already see some good results and we will continue such efforts next year in controlling the R&D and also SG&A expenses. And also, for our large vehicle models, based on its strong market performance and demand, it already proves that with the right product definition and also with our unique advantages in battery swap, we do can capture a decent market share in that segment. And in the meantime, we also see a positive trend and also huge potential for the battery electric vehicles to take up a higher market share and also penetration among large models and also premium models. And also, thirdly, we have confidence in achieving the product gross margin of 20% plus our continuous efforts on the cost and expenses control. With all that combined, we think that achieving a full year profitability on a non-GAAP basis for the year of 2026 is a reasonable target for the team. Nick Lai: Clear and certainly, I think, an exciting outcome for next year. My second question is more about the choice between in-house chain against media. Can you remind us what is our long-term strategy between insourcing and outsourcing? What are the pros and cons between these two strategies? William Li: Thank you for the question. Our NX1931 is the first smart driving chip made also with a five-nanometer process, and its tape-out mass production application on the car and also full-stack operations were all earlier than the competitors of similar performance in the industry. We also see how this in-house developed chip is contributing to both performance improvement as well as the cost structure optimization. So for the long term, we will continue our investments and also efforts in the chip-related technologies. And in the meantime, maybe you have also noticed that with media, we have announced a partnership where we are going to share our chip solution and the technologies with more industry players, both from the automotive as well as from the non-automotive industry, as we do see a good potential of applying this high computing power resonant chip on different types of devices, for example, on robots. So we will work with our tech partners together to explore more use cases and also application scenarios of our chip. Operator: Thank you. Your next question comes from Bin Wang from Deutsche Bank. Please go ahead. Bin Wang: Thank you. The first question is about the margin in the third quarter. It clearly has a big margin drop by 4.4% by its explanation because of cost reduction. Since the just enough. Do you think because of the mix because in our IT, has been a volume contribution more than 20,000 units. Can you break about the margin driver? How much came from the margin from the onboard LID? How much from the cost reduction? Really construction was the key item you actually got cost the job in the number three quarter. Thank you. William Li: Thank you for the question. As you've mentioned, our vehicle growth margin result in Q3 and the improvement from the previous quarter, this is majorly driven by two factors. The first is the cost reduction contributed by the supply chain driven by the increase in our sales volume. And the second factor is the sales and the delivery of the L90, which is a high-margin product that we have started to deliver from Q3 in comparison to Q2. We have delivered more than 20,000 L90 contributing better margin performance than the L60 in the previous quarters. These are two major drivers of the gross margin improvement in Q3. As for the specific breakdown, I will also share more information offline with you. But here, I can share with you some of the vehicle margin performance model by model. For the new ES8, as mentioned by William, the vehicle margin is 20%. Of course, we didn't start the delivery of the ES8 until late Q3, so its actual contribution in the volume side is relatively small. And for the ET5, ET5T, their vehicle gross margin is between 15 to 20%. And for ES6, and EC6, their vehicle gross margin is over 20% and even reaching 25% as these are already products being in the market for a while. We have already worn off the new car bus on this model. And for the L90, the vehicle margin is around 15 to 20%. Overall speaking, for the new models plus the onboard L90, they do have a pretty good vehicle margin performance. Bin Wang: My second question is about your latest chip joint venture with Xcela. This is maybe not for shareholders with a 36.4% stake in the company. My question is number one, why did you choose this partner, Xcela, from Chongqing? Why not somebody else? Secondly, what's the best model about this joint venture? Is it just a sales company? And it's always actually you really made a joint venture to make a check by itself. Meanwhile, do you actually get any license fee income already from the store manager? Because this is to be will save your chips. Thank you. William Li: Thank you for the question. Yes, some media has covered the establishment of this chip joint venture. And, also, we are leveraging our partners of this joint venture to sell our chip and also our IC design capabilities to other clients and also potential users. But this is not an exclusive partnership with you. We have the possibility and also the opportunities to sell our chip solution and the product to other partners and companies from our site. So that's one part of the way to sell that solution. We can also leverage our partners' resources to provide our chip solution to other car companies or other clients and they will be acting as a tier one providing such a solution. In the meantime, as mentioned, we also see opportunities of applying such a chip in the non-car or the non-automotive industry. So that is also a pretty common practice for car companies to share their technologies across different industries. And for our partners, they do have mature experience and also skills in the industry, in the design industry. They also have their own client and also network connections. And, they have some chip products that can be complementary to our chip across different scenarios. So overall speaking, we believe that this is a win-win partnership. Operator: Thank you. Your next question comes from Jeff with Citi. Please go ahead. Jeff: Hi. This is Jeff from Citi. My first question is on the 4Q ASP. So it looked like the 34 billion of revenue guidance should match with vehicle ASP. Up 12% Q on Q at the 246,000 RMB. So if the GB margin reaches 18%, that's around 6 billion gross profit. Right? So this is my first question. And my second question is the first quarter. Because we recognize the 4Q guidance, such as the revenue up 56% Q on Q. Right? And the GP margin reached 18%. But having said that, entering the first quarter next year, our volume is not going to drop back to the third quarter level. Right? And secondly, it looks like our high-margin products, the Q on Q volume, in the first quarter is going to be stable. So, therefore, the product mix should further improve into one queue. On a Q on Q base. So my second question is would the first quarter vehicle margin also stay closer to the 18% level because the higher margin products contribute more to the mix. William Li: Thank you for the question. Regarding the average selling price, it will increase in Q4. This is mainly driven by the sales of the high-margin product, the ES8. As for the full year, our volume guidance for the year, that is around 40,000 units, and most of this result will be happening in Q4. So it is also contributing to the improvement. And regarding your second question on the gross margin outlook for Q1 next year, well, normally, Q1 is the low season of the automotive industry. So overall speaking, the soft volume in Q1 will not be as good or as high as we normally expect for Q3 and Q4 in the previous years. But as also mentioned, in Q4 this year, we may not see the common sales spikes fueled by the seasonality. In that case, even if we are going to encounter the low season in Q1 next year, the impact or the reduced or the decrease from Q4 this year to Q1 next year won't be that significant in comparison to the previous years. Not to mention that we also have the ES8 order backlog that will last into the next year. This will also help to offset the seasonality impact in Q1 next year. So overall speaking, our operations and also volume forecast for Q1 next year will not be as good as in Q4 this year, but will also not be as low as in Q1 this year. So overall speaking, the vehicle gross margin falls into the same trend. It will be lower than the margin outlook we have for Q4 this year, but will be better than Q1 last year. Operator: Thank you, Jeff. Your next question comes from Ming-Hsun Lee with Bank of America. Please go ahead. Ming-Hsun Lee: Hello, William. This is Ming. So my first question is regarding your overseas plan because I think in the past few years, you have built several sales channels in Europe. And could you give us more of your strategy for overseas expansion for the next few years? Thank you. That's my first question. William Li: Thank you for the question. We entered into Europe in 2021. And from 2021 to 2024 in the past several years, we've been doing direct to customers or direct to users, the direct selling model for the European market. Yet in the meantime, with all the external factors, such as the tariffs in the EU, we also started to realize that for a broader market entrance, we do need to rely on and leverage more on the partner's support and resources. That's why starting this year, we have started to look for local partners for our market entry. Right now, we already have identified high-quality partners in more than 10 countries and regions, and the Firefly will be the first brand where we introduce to the overseas markets leveraging our partners' resources and network. The product will become available not only in Europe, Asia, but also in the Middle East and South America. So overall speaking, for the global market expansion, we are switching our business model from the direct-to-selling business model to a more partner-based and also local partner-supported business model. And also for the Firefly and its product, it's actually a very good product suitable for broader markets and also its European version and right-hand drive version already developed. Ready for the global market entry. So we do have confidence in the global expansion of the Firefly product. And in the meantime, we are also developing the Onward product for the global market. It is also a brand with a reasonable price range and product set lineup for the global market expansion. As for the new brand, as it targets the premium segment, it does take patience and time to establish brand awareness on the new product. In that case, we are also more patient and also more long-term for the global market expansion of the new brand. So overall speaking, in China, we started with the new premium one, and then we have the Amo brand and the Firefly. But for the global market expansion, they will take the opposite way where we will start with Firefly and then when Amo has the product ready for the global market, we will then push out Amo and then NIO. Ming-Hsun Lee: Thank you, William. My second question is regarding the expansion of more mass market opportunities. So since Amo is very successful in L90 and also recently, L60. Volume sales also continue to grow. So in the future, do you expect to launch more products under the Amo brand and to have more business opportunities for the segment at the 200,000 RMB or even below? Yeah. Thank you. William Li: Thank you for the question. For the Amo brand, it is defined as a family-oriented brand for the mass market. So just like Toyota and Volkswagen, for the long term, we do need to create a wide and broad product bandwidth to cater to more needs and also to cover more price and market segments. So for the long term, for the Amo brand, our price bandwidth will be ranging from 100,000 to 300,000 RMB. Within that range, we are going to offer more diverse products and options for our users to choose from. We started with L60 priced around 200,000 RMB. And for the L90, the fully loaded one has a price point of around or close to 300,000 RMB. And next year for the L80, it will also be between 200 to 300,000 RMB. So that is already a plus segment captured by the existing three products. In the meantime, we are also developing a new product platform where we are targeting the price range below 200,000 RMB. We believe that with this diversified product and price lineup, plus a more mature power swap network, we are able to achieve a reasonable market share in the price range from 100,000 to 300,000 RMB. This is also the single largest price segment in the market in China's passenger vehicle market with a total volume of 15 million. In such a large market, there's no reason for us not to launch enough products to capture a sufficient market share. Operator: Thank you. Your next question comes from Xing Chang with CICC. Please go ahead. Xing Chang: Hi. Thank you for taking my question. I have only one question, a follow-up question. Regards to the R&D expense. We have already seen our R&D expense in the third quarter decreased a lot to our previously guided level. So but in the industry is increasing investment in intelligence and also AI-related other areas. How do we allocate our limited R&D expense and how do we balance the short-term R&D efficiency and also long-term R&D cost? William Li: Thank you for the question. Actually, this year, our major focus in the R&D activities is to improve the efficiency and also to identify the priority of different R&D activities and projects. In that regard, the CPU mechanism has played a very important role in helping to make useful use of the R&D investment and expenses. In the meantime, we will also make sure that we will not lose our long-term competitiveness as that is a baseline that we will not cross. So with the CPU, we are pleased to see that even if we're dialing back on the R&D expenses in the recent quarters, yet we still maintained the R&D capabilities and competitiveness in the 12 full-stack capabilities for the smart TV. So we're also confident to control to continue that competitiveness. And, also, in the past several years, we've made major investments in developing the fundamental technologies for the core EV products, including our chips, operating systems, intelligent chassis, and also 900-volt high voltage architecture. As the foundation is already laid for the future product and technology platform, the follow-up iterations won't be as costly as developing the foundation and also the fundamental as the future iterations will also get more efficient in utilizing limited R&D resources. And also regarding the AI technology and its applications, like the smart driving and also our AI companion, Nomi, as well as the internal management and efficiency tools, we will continue our R&D intensity and efforts, but we'll achieve that in a more efficient way. And in terms of using algorithms and data, we actually have identified some good practices and approaches that can be more efficient than simply putting up investments or resources for the sake of achieving a high computing power or data performance. So we have identified some approaches with higher return on the investment. Actually, in the AI industry, the success of the deep sick has also proven that you don't need to make costly investments into developing a good large language model performance. So it's the same practice for us. Not to mention that we can also leverage our collective artificial intelligence equipped on all the vehicles and also our data close loop with that to achieve a same level of computing performance, we actually need to use that much computing power as our competitors or other peers are doing. So overall speaking, in terms of the R&D, we have been putting more focus on the return on investment evaluation as well as doing a better priority for our R&D activity. Xing Chang: Yes. Thank you. I get it. Thank you. Operator: Thank you. Your next question comes from the line of Yuqian Ding with HSBC. Please go ahead. Yuqian Ding: Thanks, team. I got two questions. First one is, could you share the cost benefit when we hit the volume threshold? The current run rate is half a million now. And it's only gonna get higher next year. What benefit can we get, let's say, and all the critical components that have high weight in the bomb structure? William Li: Thank you for the question. As mentioned, when the source volume reaches a certain level of scale, we will actually see how the economy of scale is contributing to the improvement in the financial performance, and it's mainly contributed where it's mainly from two perspectives. The first is regarding stronger bargaining power along the chain. This can also help improve the vehicle cost structure as you already see in our Q3 and Q4 vehicle margin guidance. And for the next, we don't have a clear picture regarding how much it will be contributed by the economy of scale from the supply side. Yet, as mentioned by William, our margin target for next year is 20%. That will actually partially be driven by the economy of scale on the supply side. And the second is regarding the improvement in manufacturing efficiency and cost optimization. Driven by the manufacturing as we improve our sales volume, the overall amortized manufacturing cost per unit will be gradually optimized. That will also contribute to the improvement in the cost structure of our products. Yuqian Ding: Thank you, Stanley. The second question is regarding next year's new model. Could you help us to put in context the potential higher scale and also the mixed impact? We talked about the bigger vehicle has better margin. But we also talked about the Amo L90 still 15 to 20%. So L80, will be below, 90 in terms of the pricing. Presumably. Will there be dilution or joint on those scale outweigh? That? William Li: Thank you for the question. As mentioned, the three new large SUV models that we're going to introduce next year, they are all positioned at the higher end of the price spectrum of their respective segment. We haven't finalized the prices for these new models yet. Yet we already expect more significant margin contribution by these three models. Not to mention that these three large models are fully synergized with the current audio ES8 and L90 from the cost structure. So this year and next year for the cost structure for the cost optimization and the cost-saving opportunities, that we've identified on the ES8 and L90 can also be carried over to these three new models. So with five large models combined, we expect them to contribute to the good product as a good product performance as well as on the margin levels. Overall speaking, achieving 20% of equal margin. Yuqian Ding: Thank you. Operator: Thank you. As there are no further questions, now I'd like to turn the call back over to the company for closing remarks. Rui Chen: Thank you again for joining us today. If you have any further questions, please feel free to contact our Investor Relations team through the contact information on the website. This concludes the conference call. You may now disconnect your line. Thank you.
Operator: Ladies and gentlemen, thank you for standing by. Welcome to the B.O.S. Better Online Solutions Ltd. Conference Call. All participants are at present in listen-only mode. As a reminder, this conference call is being recorded and will be available on the B.O.S. Better Online Solutions Ltd. website as of tomorrow. Before I turn the call over to Mr. Cohen, I would like to remind everyone that forward-looking statements for the respective company's business, financial condition, and results of its operations are subject to risks and uncertainties, which could cause actual results to differ materially from those contemplated. Such forward-looking statements include, but are not limited to, product demand, pricing, market acceptance, changing economic conditions, risks in product and technology development, and the effect of the company's accounting policies, as well as certain other risk factors which are detailed from time to time in the company's filings with the various securities authorities. I would now like to turn the call over to Mr. Eyal Cohen, CEO. Mr. Cohen, please go ahead. Eyal Cohen: Thank you. Good morning, and thank you for making the time to meet with us today. Joining me is Mr. Moshe Zeltzer, our Chief Financial Officer. B.O.S. Better Online Solutions Ltd. integrates cutting-edge technologies to streamline and enhance supply chain operations. We delivered strong growth in the first nine months of this year. Revenue grew year-over-year by 28% to $38 million, continuing our record performance this year. We are strategically expanding overseas by partnering with international subcontractors of our Israeli defense client. These markets are relatively untapped by B.O.S. Better Online Solutions Ltd. and represent potential growth for us. We see India as a major target market because it is a global hub for wire and connector assembly, where we have a competitive advantage. Through this approach, our international revenues grew by 24% year-over-year, demonstrating the growth potential in international markets. Our net income grew year-over-year by 54% to $2.8 million, while our revenues grew by 28%, showing our ability to convert revenue into bottom-line results plus profit leverage as we scale the operating base of the business. We have demonstrated consistent profitability with steady net income growth, achieving a compound annual growth rate of 51% from 2021 through 2025. This result underscores the strength of our defense-focused strategy, reflecting years of deliberate investment in product diversification and operational excellence that position us to capitalize on the defense sector's robust growth trajectory. Given our strong execution and stable backlog exceeding $24 million, we are raising our full-year 2025 financial guidance. We now expect to meet the high end of our previous guidance range of $45 to $48 million in revenue and $2.6 million to $3.1 million in net income. There are several tailwinds that have accelerated our growth momentum and we believe will support our long-term organic growth. First, as you know, the global increase in defense budgets. Second, replenishment and expansion of Israeli Defense Forces inventory and equipment and vehicles. Third, the potential stabilization and improving conditions in The Middle East, which is a pivotal tailwind for the growth of the Israeli civil market and will positively impact the growth of our RFID division. These drivers support our continued organic growth in conjunction with our outbound sales efforts. We continue to look for opportunities to enhance our growth with strategic actions that fit our business and diligent pricing parameters. Through the combination of these efforts, we intend to grow both over the coming years. With that overview, I will turn the call over to Moshe Zeltzer, our CFO, to discuss our financial position. Please, Moshe. Moshe Zeltzer: Thank you, Eyal. Financial validation has never been stronger. Cash and equivalents grew to $7.3 million, up from $3.6 million at year-end. Our shareholders' equity amounts to $25 million, which accounts for 66% of our balance sheet. We have positive working capital of $18 million and $1.1 million in long-term loans secured by real estate we are using for our own operation. This strong balance sheet gives us the flexibility to capitalize on opportunities as they arise, supporting organic growth and strategic acquisitions. Our valuation offers attractive upside compared to Russell 2000 index multiples. Price-to-earnings ratio Russell 2020 versus B.O.S. Better Online Solutions Ltd. at 11. Price-to-book ratio, Russell 2000 at 2.2 versus B.O.S. Better Online Solutions Ltd. at 1.7. Thank you for your time and attention. We are happy to take your questions. Eyal Cohen: Hi, y'all. Can I ask you a question? Scott Weiss: Yes, please. Great. This is Scott Weiss at Semco Capital. Hi. Eyal Cohen: Hi. Great quarter. Terrific quarter. I have a few questions, and if it's okay, I'd like to ask them one at a time. In the press release, you highlighted that you're excited about your expanding opportunities with new and existing customers. Can you highlight a couple that you're particularly enthusiastic about and specifically new customers? Eyal Cohen: Yeah. The main customer that we are joining to our portfolio is many overseas clients, mainly from India. And I can tell you that in the recent week, there was a huge delegation here from India, including ministers from India, and we were happy to meet with many companies from India, and those are the major clients that we are joining our group. Scott Weiss: Okay. When would you expect revenues to hit the bottom line? To impact your P&L? Eyal Cohen: What do you mean? Scott Weiss: When do you expect revenues from this new Indian customer to impact your P&L? Eyal Cohen: Yeah. It already impacted this year, this nine months, as we already see the growth in revenues from the international market by 24% as compared to the comparable period last year, and this has mainly come from the Indian market. And it's a process. Gradually, we are increasing our market share in this territory. Scott Weiss: Okay. Thank you. Question, can you expand on the loss in the RFID division? And exactly what you mean by logistics center slowdown in Israel? Eyal Cohen: Yeah. The RFID division engages in the civil market, not in the defense market segment. And this segment had a very challenging time in the recent two years because of the conflict in The Middle East, and it adversely affected the business. In the recent two quarters, we also saw the effect of the US dollar devalued against the Israeli shekel, which also adversely affected the business. But in the fourth quarter, because of some measures we took operationally and in the business model as well, and the change in the environment in Israel, especially in the geopolitical environment, we see a rebound in demand. We are optimistic about returning to profit in the fourth quarter. Scott Weiss: Okay. Great. And then that was my next question. Can you expand on the currency impact? And how much can you quantify the effect it had on your P&L? And do you hedge? And if not, are you going to start hedging? Eyal Cohen: Mhmm. Yes. So the US dollar devalued against the Israeli shekel by about 11% in the six months ended September 30 this year. Actually, the second and the third quarter. Since most of our operational expenses are denominated in shekels, and revenues are primarily in dollars, this currency movement created approximately half a million dollars in additional cost pressure on operating income during this period, or roughly about a quarter million dollars per quarter. As I mentioned before, we are proactively addressing this headwind through strategic sales price adjustments initiated in the fourth quarter and operational efficiency improvements. Regarding hedging, we are hedging the balance sheet exposure. For every hedging, each hedging has a limitation period. We do not believe that it's a temporary exchange rate; I think it will be with us for the long term. So any kind of hedging on the dollar is temporary. We are trying to find a solution for the long term. Because of that, we are in a process of such price adjustments and operational efficiency improvements. Scott Weiss: Okay. One more question, and I'll jump back in the queue. One of the potential concerns on your P&L and continued growth is the impact of the end of the war in Gaza. Can you address this? And how should we think about the end of the war and its impact? Eyal Cohen: I think there are two sides to the coin. On one side, we are in the defense segment. In the supply chain division, the biggest division in B.O.S. Better Online Solutions Ltd., 90% of its business is in defense, and its customers are the major clients in Israel. So there is a direct impact of the tension. On the other hand, we have the RFID division, which is in the civil market. The civil market does not benefit from the war. But because we have the biggest exposure to defense, we are growing in the top line and in the bottom line. Scott Weiss: Historically, have you grown faster on the defense side in a time of war or time of peace? Eyal Cohen: Over the years, the main growth came from the supply chain. Even in times of peace, those clients are the biggest exporters in Israel, and they grow year by year. Also, the defense budget of Israel is growing year by year, even before the war. I am not sure about the number, but I think the average growth rate of the defense market in Israel over the years was about 7%. It is growing, and sometimes in some periods in a sharp way, like in the recent two years, about 17% each year or more. In normal years, about 10%. Scott Weiss: Thanks. I'll jump back in the queue. Eyal Cohen: Thank you. Operator: Good morning, Eyal and Moshe. Congratulations on another great quarter. Todd Felte: I see that you have $7.3 million in cash. I assume that amount is rising in the current quarter. You've talked about M&A possibilities. Will you have to raise equity, or will you be able to use cash for any M&A activity? Eyal Cohen: Hi, Todd. Nice to meet you again. Yes. Our cash position was strong at the end of the third quarter, with over $7 million and zero bank debt. That continues to grow in the fourth quarter. For M&A, we are targeting profitable Israeli defense sector companies with complementary products serving our major clients and their subcontractors. Acquisition targets of up to $10 million, and bank financing is typically available for approximately 50% because it's a profitable company. 50% of the purchase price. We can execute this transaction using our existing cash on hand without requiring equity raising, while maintaining sufficient working capital for operation and organic growth. Todd Felte: That's great. Also, can you give us some clarity on the amount of the percentage of your defense business, which is in Israel, and the amount that's international, and how you expect that to change? I've seen a lot of contracts from India and Europe, and I was hoping you could quantify that for us. Eyal Cohen: Yeah. I was really showing the chart. In the nine months, out of the $38 million, $3.6 million were sales overseas related to the supply chain, related to defense. We are taking measures and allocating resources to increase this number by being active and with an active approach, especially in India. Maybe even to change our approach in how to operate the sales in India, and we see a lot of potential in this market. I believe that this number of $3.6 million that reflects a 24% increase in sales overseas will continue. We will see this trend continue in the fourth quarter and in 2026 as well. Todd Felte: Okay. I know you talked about opening up a branch office in India. I assume that's where a lot of the expansion is going to be. Is there any update to that office you're going to open over there? Eyal Cohen: Yeah. We are checking various options on how to make it in the most efficient way. We are taking very conservative measures on how to allocate our financial resources overseas and how to do it in a very lean way. I believe that next year, we'll see the actual results of our plan. Todd Felte: Okay. I'll hop back in the queue. Congratulations again on a great quarter. Eyal Cohen: Thank you. Thank you, Todd. Operator: How's everyone? Igor: Hello. Could I ask you this question? Hello. My name is Igor. This is my second call with you, and congratulations on a strong quarter. My question is, Israel is expensive. Everything in Israel is expensive, any operations. Now it's getting even more expensive with a stronger shekel. Now that you're becoming more and more of an international company with international sales, any thoughts of spreading the cost and moving some of your operations outside of Israel? Given that it's so expensive to do anything in Israel? Eyal Cohen: It's a good idea, but maybe it's a good idea. We need to think about it. Actually, I don't see any unit we can operate overseas. But one of the options, as I mentioned to Todd, is to instead of doing the sales to India from Israel, to do the sales in India from India. This is the first example of how we can reduce our cost. The main approach to do sales in India was not to save cost, but to increase sales. But we can get both of the things together. But it's a good idea. I need to be honest. I need to think about it, and I will keep you updated in the next call. Igor: My other question is, so I know that the last years were sort of overshadowed by the Gaza war and other people would refer to this. Historically, if you take many, many years, your company is a bit of a cyclical company. Some periods of time, there's more demand, some periods a little bit less demand. How do you intend to make the company a little bit less cyclical and more like sustainable growth? What is your strategy like? What do you see the company like five years down the road? Eyal Cohen: I think by going overseas to increase our sales overseas, as we saw in the number, like out of the $38 million, just $3.6 million were international sales. If you increase it, we can reduce the cycling. Growing by acquisition and adding more, increasing the portfolio of our offering, and by that, we can eliminate the exposure that you mentioned. But the structure of B.O.S. Better Online Solutions Ltd. is that we have the supply chain in defense, and we have the RFID in the civil, and we have the robotic in between. So we are already spread. But I have to be honest with you, we are in defense for many years, more than years. It's all the time growing. I remember a cycle of a slowdown in this segment. I'm sure that in three or four years, the demand will come back to normal after the situation in The Middle East and in Europe. But I believe it's the best segment to attach to. Igor: Okay. And my last question about the potential for M&A. Obviously, you put 4.5 million at the market option. Now, and you have plenty of cash. You don't lack for any cash. So do you have are you looking at any specific opportunities right now? Or you just put it just in case? What is your thought about M&A, like, for the next year or two years? Eyal Cohen: I hope that next year, we will close on M&A. This is the working plan. My plan is to close one, and I hope that every two years, we will be able to close an M&A. By that, with the organic growth, to reach the $100 million bond, this target. But those are plans, and we are working according to those plans. Igor: Just curious. I understand this might be opportunistic, but why don't you look to borrow to do an M&A and potentially look at the equity component given that your stock is not particularly high? So that would be maybe a little bit suboptimal versus borrowing from a bank given that you're a pretty solid company, with good cash flow and earnings. Eyal Cohen: I didn't understand your question. Igor: So it looks like you put a potential M&A, you have an option of 4.5 million dollar equity. Obviously, I don't know what the M&A opportunity is going to look like, but I would hope that your first intent would be to borrow money from the bank to do an M&A versus equity given that your equity is relatively low, given your valuation. Eyal Cohen: Actually, how you think about it? As I mentioned to Todd, in case of doing an acquisition even of $10 million, which is a frame of investment we are targeting, assuming 50% by bank loans because it will be a profit target company. So for the rest, the $5 million, absolutely, we don't need to issue more stock. We have it on hand. Operator: Okay. Eyal Cohen: Alright. Thank you so much. Yeah. We have $7.5 million as of September. The cash continues to grow. I don't see any need to raise more equity to consume an M&A. Igor: So you just have a just in case in case a big opportunity comes up that you have a 4.5 million dollar offering at the market. Eyal Cohen: We see it. We have tools like every public company should have. Like the shelf perspective that we have, and we haven't used for four years. Like the ATM that we have and we haven't used since the date it was filed. It's filed? And the unused credit line that we have in the bank is not used. So we have all the facilities we should have. But, actually, in order to consider a $10 million M&A, we don't need to raise to use any of those tools except for the unused credit line. Bank credit lines. Igor: How much do you have available credit as of now approximately? Eyal Cohen: Sorry? Igor: How much credit do you have unused as of now? Moshe Zeltzer: Right. Eyal Cohen: You're One million for the real estate. No. Unused. Unused. We have unused for ongoing use, not for the acquisition. We are Oh, I see. Okay. Yeah. So that's a Igor: capital I understand. Yeah. It's something like Eyal Cohen: 1.5 to $2 million unused credit line for revolving credit for organic growth, but we already checked with the banks in case of a model of acquisition, a profitable company. I believe we can get 50% financing from the bank for the acquisition. Yeah. Igor: Okay. Thank you. Eyal Cohen: You're welcome. Scott Weiss: Eyal, from an investor perspective, have you finalized your dates as to when you're going to come to The US to meet investors? Eyal Cohen: Yeah. I think it will be April next year. In between, I will participate in a virtual summit. We will announce it. I will continue to do ongoing one-on-one weekly meetings with potential investors. Moshe Zeltzer: Scott? Scott Weiss: Yeah. I got it. Thank you very much. Moshe Zeltzer: You're welcome. Eyal Cohen: Any further questions? No. No follow-up. I'm good. Scott Weiss: Although, I'd like to meet you when you come to The US for sure. Igor: Yeah. We're meeting. Eyal Cohen: So thank you again for your participation. If you need more details or would like to follow up, please feel free to reach out to us. Thank you. Moshe Zeltzer: Thank you. Bye-bye.
Operator: Good day, everyone, and welcome to Nutanix First Quarter 2026 Earnings Conference Call. At this time, participants are in a listen-only mode. After the speakers' presentation, there will be a question and answer session. You will then hear a message advising your hand is raised. To withdraw your question, simply press star, one one again. Please note this conference is being recorded. Now it's my pleasure to turn the call over to Nutanix Vice President of Investor Relations, Rich Valera. Please go ahead. Good afternoon. Rich Valera: And welcome to today's conference call to discuss First Quarter Fiscal Year 2026 financial results. Joining me today are Rajeev Ramaswamy, Nutanix's president and CEO, and Rukmini Sivaraman, Nutanix's CFO. After the market closed today, Nutanix issued a press release announcing first quarter fiscal year 2026 financial results. Operator: If you'd like to read the release, Rich Valera: please visit the press releases section of our IR website. During today's call, management will make forward-looking statements, including financial guidance. These forward-looking statements involve risks and uncertainties, some of which are beyond our control, which could cause actual results to differ materially and adversely from those anticipated by these statements. For a more detailed description of these and other risks and uncertainties, please refer to our SEC filings, including our most recent annual report on Form 10-K, as well as our earnings press release issued today. These forward-looking statements apply as of today, and we undertake no obligation to revise these statements after this call. As a result, you should not rely on them as predictions of future events. Please note, unless otherwise specifically referenced, all financial measures we use on today's call, except for revenue, are expressed on a non-GAAP basis and have been adjusted to exclude certain charges. We have provided, to the extent available, reconciliations of these non-GAAP financial measures to GAAP financial measures on our IR website and in our earnings press release. Nutanix will be participating in the UBS Global Technology and AI Conference in Scottsdale on December 1, the Raymond James TMT and Consumer Conference in New York on December 8, and the Barclays Global Technology Conference in San Francisco on December 11. We hope to see some of you at these events. Finally, our second quarter fiscal 2026 quiet period will begin on Monday, January 19. And with that, I'll turn the call over to Rajiv. Rajiv Ramaswamy: Thank you, Rich. And good afternoon, everyone. In our first quarter, we saw solid demand for our solutions, with bookings that were slightly ahead of our expectations, and continued progress with our partners. However, the solid performance of the business didn't translate into revenue within the quarter as previously expected. Late in the quarter, we saw more business than expected with start dates outside of the quarter. This resulted in some revenue being shifted out of Q1. As we evaluated the impact of this recent change in our business mix on our fiscal 2026 outlook, we now expect to see more revenue deferred than we had previously planned, driving a reduction in our full-year revenue guidance. Rukmini will provide more details on these changes in her comments. But there are a few key points I'd like to make. First, our view of the fundamentals of our business and bookings growth expectations for the year remain unchanged. Second, these changes do not impact our free cash flow expectations for FY '26, which we are modestly increasing. And finally, this is solely a timing issue, and the amount of revenue we expect to recognize over time from business booked in FY '26 remains unchanged. With that said, in our first quarter, we delivered quarterly revenue of $671 million within our guided range and grew our ARR 18% year over year to $2.28 billion. We also saw another quarter of healthy new logo additions and solid free cash flow generation. We continue to see success in the marketplace in Q1 with our cloud platform. Our most notable wins, a few of which I'll highlight, demonstrate the appeal of our solution to businesses that are looking to modernize their IT footprints, deploy modern apps and AI, and adopt hybrid multi-cloud operating models. One of our largest expansion wins was with a North American-based provider of agricultural products and services that is looking for an alternative to their existing three-tier virtualization solution that included a potential future path to public cloud. They chose our Nutanix cloud platform to run their mission-critical applications across their global manufacturing and business operations footprint, appreciating the public cloud optionality provided by our Nutanix cloud clusters, or NC2 capability. They also chose Nutanix Kubernetes platform in anticipation of future deployment of modern workloads, as well as Nutanix cloud management and Nutanix unified storage. Another example of a new logo win with a customer looking to take advantage of the hybrid multi-cloud capabilities of our platform was a European government agency that was looking for a solution to deploy and manage their modern applications across public and private clouds. They are planning to run their modern applications on a Kubernetes platform on top of NC2 on AWS. And we continue to add some of the world's largest companies as new customers in Q1, including a 7-figure global 2,000 new logo with an EMEA-based provider of energy products and services. This customer was looking to implement a comprehensive cyber solution. They chose the Nutanix cloud platform to run these security applications as well as Nutanix cloud management for its common management interface, superior ease of use, simple one-click upgrades, and the ability to securely run across multi-cloud environments. They also chose Nutanix unified storage for management of their unstructured data. Finally, a first-quarter new logo in our US federal business highlighted the GenAI and modern application capabilities of our platform. This government agency, looking to modernize their infrastructure and to utilize AI to enhance its effectiveness and efficiency, chose a full-stack Nutanix solution, including our cloud platform, Nutanix unified storage, and Nutanix database service, as well as our Nutanix enterprise AI and Nutanix Kubernetes platform, to support development and deployment of their modern and GenAI applications. Rukmini Sivaraman: Moving on, we also continue to make progress on our initiative to support external storage with our platform, including selling our solutions supporting Dell's PowerFlex to another global 2,000 customer in Q1. During this quarter, we also announced that Nutanix plans to support Dell's PowerStore, with general availability expected in 2026. And we remain on track to deliver our solutions supporting Pure Storage FlashArray within this calendar year. Finally, we continue to receive industry recognition in Q1. Nutanix was named a leader in the 2025 Gartner Magic Quadrant for Distributed Hybrid Infrastructure. Our inclusion in the leaders quadrant, along with several leading public cloud providers, reflects the evolution of our offering to a true hybrid multi-cloud platform. In closing, our business performed solidly in the first quarter, including bookings that were slightly ahead of our expectations, ARR growth of 18% year over year, another healthy quarter of new logo additions, and solid free cash flow performance. The change to our revenue guidance relates solely to the timing of revenue recognition. I believe the fundamentals of our business remain healthy and unchanged. We remain focused on delighting our customers while driving sustainable profitable growth. And with that, I'll hand it over to Rukmini Sivaraman. Rukmini, Rukmini Sivaraman: Thank you, Rajiv, and thank you everyone for joining us today. I will first discuss our Q1 2026 results followed by Q2 2026 guidance, and our updated fiscal year 2026 guidance. In Q1, we reported quarterly revenue of $671 million within the guidance range of $670 to $680 million, representing a year-over-year growth rate of 13%. While bookings in Q1 were slightly ahead of our expectations, we saw a larger than expected proportion of land and expand bookings with future start dates late in the quarter, resulting in a shift of some revenue from Q1 into future periods. As a reminder, under US GAAP, revenue recognition generally begins when the license starts, which means bookings with future start dates shift revenue recognition into later periods even though cash collections may occur earlier. This is solely timing-related and does not change the overall revenue expected to be recognized over time. If land and expand bookings had come in with the proportion of future start dates that we had assumed, Q1 revenue would have been above the high end of the guided range. ARR at the end of Q1 was $2.284 billion, representing year-over-year growth of 18%. NRR, or net dollar-based retention rate, at the end of Q1 was 109%, flat quarter over quarter. Note that this ARR and NRR are under our updated methodology that started with Q1 2026, as previously discussed on our last earnings call. In Q1, average contract duration was 3.1 years. Non-GAAP gross margin in Q1 was 88%. Non-GAAP operating margin in Q1 was 19.7%, towards the lower end of our guided range of 19.5 to 20.5%, primarily due to lower revenue. Non-GAAP net income in Q1 was $121 million, or fully diluted EPS of $0.41 per share, based on fully diluted weighted average shares outstanding of approximately 297 million shares. GAAP net income and fully diluted GAAP EPS in Q1 were $62 million and $0.21 per share, respectively. Free cash flow in Q1 was $175 million, representing a free cash flow margin of 26%. Moving to the balance sheet, we ended Q1 with cash, cash equivalents, and short-term investments of $2.062 billion, up from $1.993 billion at the end of the previous quarter. Moving to capital allocation, in Q1, we repurchased $50 million worth of common stock under our existing share repurchase authorization and used about $89 million of cash to retire shares related to our employees' tax liability for their quarterly RSU vesting. Both of these help to manage share dilution. Moving to guidance, our guidance for Q2 2026 is as follows: Revenue of $705 to $715 million, non-GAAP operating margin of 20.5% to 21.5%, fully diluted weighted average shares outstanding of approximately 296 million shares. Moving to the full year, our updated guidance for fiscal year 2026 is as follows: Revenue of $2.82 billion to $2.86 billion, representing a year-over-year growth rate of 12% at the midpoint of the range, non-GAAP operating margin of 21% to 22%, same as our prior guide, despite the lower revenue guide. Free cash flow of $800 million to $840 million, an increase from our prior guidance, representing a free cash flow margin of 28.9% at the midpoint. I will now provide some additional context regarding our fiscal year 2026 guidance. First, as Rajiv mentioned, it is important to note that our full-year bookings growth remains unchanged relative to our last earnings call. We are also pleased to raise our free cash flow guidance for the full year. However, as we saw late in Q1, we are seeing that the timing of conversion of bookings into revenue is evolving with our business. We believe this is due to a couple of factors, including one, increased customer demand for greater flexibility to start licenses aligned with their adoption timeline, resulting in more bookings with future start dates, and two, the growing proportion of our business through our third-party OEM partners, for which we only recognize revenue when our partners ship an appliance. As a result, we now expect more revenue to shift from fiscal year 2026 into future periods, while the total amount of revenue recognized over time remains unchanged. Second, a note on seasonality. We expect the quarter-over-quarter revenue trend from Q2 to Q3 to be similar to what we saw last year in fiscal year 2025. Third, we continue to balance prudent investments for continued growth with a focus on efficiencies and expanding margins over time. This is reflected in our updated operating margin and free cash flow guidance for the full year. In closing, we believe the underlying value of our business remains unchanged. Demand and bookings expectations are unchanged. Our free cash flow outlook is higher. Revenue is expected to be unchanged over time, but starting later. And our guidance philosophy is unchanged. With that, operator, please open the line for questions. Operator: Thank you so much. And as a reminder, to ask a question, simply press 11 on your telephone. And wait for your name to be announced. To remove yourself, press 11 again. We ask that you please keep your questions to one and one follow-up. One moment for our first question. It comes from Matt Hedberg with RBC Capital Markets. Simran: Hey, guys. This is Simran Daswal on for Matt Hedberg. Thanks for taking our question. So just to start with 2026? Yes. Hi, Simran. I can take that. So on NRR, we had talked about, as you said, some puts and takes there. Where we knew logos generally don't affect NRR directly. Because if you think of all the components that add up to our ARR growth, the first one is, you know, good retention, making sure we're retaining as many of our customers as we can. And then there is this expansion component, which is reflected in NRR. And then the third element is new logo, which then add to make up the full ARR number. New logos in general don't affect NRR. I think the point we had made in the past was that as our average deal sizes for new logos have gone up over time, potentially in some customers, we might be doing a complete migration of their estate onto the Nutanix platform. Even at the get-go. That doesn't happen all the time, to be clear. Right? There are bigger customers where it would be a migration over time. We talked about that a little bit in the prepared remarks as well. There are puts and takes here. Overall, we saw the NRR for Q1 as reported stabilize. It was flat quarter over quarter. Simran: Okay. Okay. Got it. And then could you also provide a little bit more color on fed? How did it perform relative to expectations ninety days ago? And the impact of the government shutdown? Rukmini Sivaraman: Yeah. Thank you. Let me talk a little bit about US Fed. So first, I'd say, as a reminder, we don't report US Federal as a percent of our business. Just to give people an idea. But what we have said is that US Fed has been 10% or less of our annual revenue. With the seasonal strength, of course, seen in our fiscal Q1, the quarter that we just reported. Which is fed fiscal year end. In this Q1, specifically, our U.S. Fed business saw double-digit year-over-year growth off of admittedly, off of relatively easy comparison last Q1. But we saw nice growth there. And going forward, we continue to expect a higher than historical level of variability in the US Fed business given, you know, recent personnel changes, some policy changes, of course, we just came out of the government shutdown. So given all of that, we expect some variability there. But overall, we remain optimistic on the opportunity for this business to benefit from our platform's focus on modernization, and lowering TCO, which we believe TCO being total cost of ownership, which we believe is well aligned with government objectives as well. And we have factored through all of this into our Q2 and updated fiscal year 2026 guidance. We have factored this overall uncertainty into the updated guidance. Simran: Okay. Great. Thank you. Thank you. Operator: Our next question comes from the line of James Fish with PSC. Please proceed. Jim Fish: Hey, guys. Look. Let's get right to the point here. If bookings came in better than expected and granted it's apples and oranges slightly, why did RPO bookings that you know, I'm happy that you guys are finally talking about RPO because I think it's a more meaningful metric. But why did RPO bookings themselves only 6%? Can you guys help us with what that bookings growth rate was? And and Rupini, it really shifted out of fiscal Q1, why does it seem that so much is pushed into fiscal Q4? Because if I look at your your commentary here of seasonality, it it means we have a pretty large ramp into fiscal Q4 versus fiscal Q3 then So help us out here. Rukmini Sivaraman: Hi, Jim. Yeah. Thank you for those questions. So as you pointed out, you know, we've started this quarter providing RPO remaining performance obligations in our earnings release. When before we were providing them in our filings, so in our 10-Qs and K's. We believe that this is an additional relevant metric because, Jim, as you, I think, are alluding to, RPO cap bookings activity in the period. That is expected to be future revenue. And it includes a deferred revenue, which, of course, is also on the balance sheet, and it also includes noncancelable backlogs. Those are the components of RPO. I'll also remind folks that RPO is a TCV or total contract value-based metric. And so it is you know, it has it has all of the revenue, meaning it has duration in in as well. As opposed to ARR, which is an annualized metric. Now to your question, Jim, on RPO and why we saw a small decline in our backlog component, which is part of the RPO or subset of RPO, in our first fiscal quarter. And I would say that's consistent with our historic seasonality if you look at sort of what backlog does. And then there's a small component that that is not visible, which is noncancelable That is a smaller sorry, cancelable backlog, which is a smaller proportion. And so that also typically does translate into revenue. So overall, look, I mean, look at RPO. We are pleased with overall year-over-year growth in RPO. Which is 26%. In in Q1. Your second question, Jim, I think, was on the seasonality point. So when we look at the full year, what I would say is we we still see a mix that is similar to what we've seen in fiscal year 2025 last year, for example. Example. So you look at fiscal year 2025, our revenue mix first half versus second half was 49.51 And for '26, the updated guidance we just gave you at the midpoint of Q2 and full year, it's just a touch more weighted. Towards second half. So it's not meaningfully different from what we saw last year. Jim Fish: Good. Got it. And then I I think anyone that's been following you guys for a while you know, will recall the time frame when it was out of your control. The supply chain issues a few years ago that led to you know, what we'd all call push outs. So can you walk us through in terms of what you're seeing that's similar versus different on how we should think about this sort of push out time frame? Thanks. Rukmini Sivaraman: Yeah. So why don't I start on that, Jim, and then I welcome Rajeev to to add in here as well. And maybe, Jim, it's it's a broad question. Right? So I start with first maybe broadly talking about three relevant factors that are related to the recent dynamics that we see. Our land and expand business specifically. So first, with the growth of Broadcom migrations, we're finding that these customers want to commit to us. But often need more flexibility to help them match their license deployments with their migration timeline. We have seen some of this in the past as noted in prior earnings calls. Although the impact then was minimal relative to our expectations. We saw this become pronounced late in Q1, and we now expect this trend to continue, which is why we're expecting more revenue than previously expected to be shifted out of '26 and into future periods. That was the primary factor in the Q1 revenue performance. The second one is a growing proportion of our business is coming through our third-party OEM partners. For which we only recognize revenue when our partners ship an appliance. Third, and perhaps more directly to your question, Jim, we don't believe supply chain shortages or longer lead times were a meaningful driver. Of the revenue performance in Q1. However, based on what we have been hearing anecdotally about component shortages, and the potential for longer lead times. We believe supply chain tightness could impact the business going forward. So we believe now that we have more refined insight based on recent trends on, you know, orders with future start dates, partner shipping timelines, and the extent to which these factors impact timing of revenue. Now with all that said, I'd like to reinforce a few important points or reiterate a few important points that we said in the prepared remarks. We believe the underlying value of our business remains unchanged. Demand and booking expectations for the year are unchanged. Free cash flow outlook is higher. Revenue is expected to be unchanged over time. But starting later. And our guidance philosophy is unchanged. Rajiv, anything you would add to that? Rajiv Ramaswamy: Yeah. Let me provide a bit more color on the supply chain aspect. I think you covered the other aspects well, Rupini. So on the supply chain, as you said, I mean, we didn't believe that supply chain constraints were a meaningful factor in our Q1 results. But as we all know, there is a big massive AI build-out being done by a handful of large companies. And that has a potential, and it still seems to be starting to cost supply shortages in the industry. Now we don't see this directly. But we are hearing anecdotally about component shortages and the potential for a long lead times. Now this could impact our land and expand business. Going forward. Renewal talent. Affected. So we are monitoring this closely, and and we have factored in a modest tightening of the supply chain into our updated outlook. Now again, in terms of looking at the supply chain per se, while, you know, again, we don't control the supply chain supply chain ourselves, but we have done a few things to help mitigate supply chain issues. I'll say three things. There are four things, actually. First is we do have more server partners now than we've had in the past. Notably, we've added Cisco as a server partner. So our customers have a choice of settlement vendors to pick from. And, you know, they can do do that based on who's got the best supply. Second, we have continued to expand our hardware compatibility list. So that we can include more existing server configurations that customers have already deployed. Run our infrastructure. If they're, for example, looking to get it with their existing software and putting our software on, we can run that more on the existing hardware that they've deployed. Third, we've also added additional external storage options. Such as Dell and Zoom Pure Storage. That mitigate the need for customers to purchase new hardware to run our software. And and finally, we also have more offerings in the public cloud including now NC2 on Google Cloud, our Kubernetes offerings, etcetera. So these are all I I think the the overall set of things that we are doing on our end too, to provide broader applicability of a software across different hardware. Operator: One moment for our next question, please. It comes from Matthew Martino with Goldman Sachs. Please proceed. Matt Martino: Yeah. Thanks for taking my questions. First one for me, like on the revenue that slipped from Q1 into future periods, like how much of that was tied to customer requested future start dates versus OEM shipment timing? Versus simple deal slippage? And I guess, like, what evidence more broadly do you have that this is timing only rather than emerging demand softness? And then I have a follow-up. Rukmini Sivaraman: Hi, Matt. Thanks for the question. Let me start. So in Q1, the revenue performance in Q1 think I I wanna be clear, was primarily related to the proportion of orders that we saw with these future start dates. And as we said, bookings in in Q1 were ahead of what we had expected going in. And so it's that bookings view, Matt, that gives us that that we were alluding to when we said that, look. We have seen bookings to come in Q1 in slightly ahead of what we had planned. And our view for the full year on bookings also remains unchanged. From before. But the primary factor of Q1 revenue coming where it did, which was within the range, and as we as we said, it was proportion had come in as we had assumed, it would have been above the high end of the range. Matt Martino: Got it. And then for a follow-up, just given the commentary on deal deal recognition landing in later periods, I mean, how should we think about the duration and the timing there as we kind of think about framing our models for 'twenty seven, kind of given the commentary that you expect unchanged bookings growth but a delay in that rev rec? Rukmini Sivaraman: Yeah. So when we think about '27, think it's part of your question, Matt, which is what is this change for 'twenty six imply for fiscal year 'twenty seven, if I were to paraphrase? Your question. Look, we have given you our view and of revenue for this year. Revenue growth in '27 is you know, as in any year, is dependent on three factors. Business deferred from '26 into '27, business booked in '27, and then how much we book in '27 that might get deferred into future years. So there's a net effect that, as you can see, along with actual bookings performance itself in '27. We look forward to providing more color on that really anything beyond fiscal year twenty six during our Investor Day in April, Matt. Rajiv Ramaswamy: Okay. The only thing I'll add to that, Upani, in terms of the demand side of this equation you talked about, of course, bookings coming in slightly ahead of expectations. The other thing you could look at, Matt, also is the fact that our cash flow is fine. Right? In fact, we're actually slightly taking up our free cash flow guide. And we're still collecting cash on all those bookings mostly upfront. Operator: One moment for our next question that is from Samik Chatterjee with JPMorgan. Please proceed. Samik Shiji: This is MP on behalf of Samik Chatti from JPMorgan. I I just wanted to ask on the customer spending plans, we have seen hardware cost particularly impacted by the increased component and component cost. So like, does that anyway impact the overall propensity of, like, customers and terms of spending towards IT? And, also, like, if you could help us understand FY '26 guide adjusted for the timing issues. So I'll talk about the first one. I mean, I'll we about the supply chain. I think look. I mean, hardware, again, prices could change. Prices go up. Prior lead times could go up, and like I said, our you know, approach is to provide fundamentally, to provide more diversification to customers. So that so that they can try and arbitrate amongst all the hardware providers and provide be providing the broadest flexibility to run our platform, right, on run our software on, you know, as many hardware platforms as they can. That's our approach of dealing with the hardware issues. We don't control the hardware directly. Right? Now we have it to your question. We haven't seen any drop in demand in terms of customers saying, oh, yep. Prices have gone up. Therefore, we're not going to buy as much. We haven't seen that at this point at all. Rupin, you wanna talk about the guide? Rukmini Sivaraman: Yes. So I think the question was for the full year '26 guide, what did it what would it have been if not for the timing of of revenue? And, look, I think a reasonable starting point to look to look at that is what we've guided last quarter. Which was $2.09 to $2.09 4. And our current guide is $2.08 2 to $2.08 6. And as I said, the the reason for that is we're expecting more revenue than previously expected to shift out out of fiscal year twenty six and the factors like we talked about. Right? One is this the this the fact that more customers want to commit to us but are looking for more flexibility to help them match their migration timelines with one they need licenses from us. Second is the growing proportion of our business that's coming through third-party OEM partners, for which we only recognize revenue when our partnership and appliance. And the third one, which we, you know, we really haven't seen thus far, it was not a factor a meaningful factor in Q1 revenue, is that these some of the supply chain shortage or longer lead times, were exciting to hear about. Anecdotally and which you alluded to as well. Samik Shiji: Thank you. Oh, and my follow-up question would be, like, have you seen any increased competitive increased competitiveness across the space over the last ninety days or something? Like, overall view around the competitive environment. Rajiv Ramaswamy: I would say, nothing has changed really on that front. We're seeing the same set of competitors as we've always competed with, and we really haven't seen any any major change. In the dynamics. Like I said, I think the the migrations that we're seeing customers do onto our platform, Right? I mean, they tend to be staged over time. Right? It's not everything coming upfront. And we're seeing as as we see more of those migrations and explained, I think that's driving, you know, the customers to need more flexible start dates. Right? In terms of, you know, when they actually want to activate their licenses so that they can activate those whenever they're ready to actually do the actual migration. So that I think is is is what we've seen, and I don't don't the competitive side of the equation really hasn't changed. Operator: Our next question comes from the line of Wamsi Mohan with Bank of America. Please proceed. Ruplu Bhattacharya: Hi. It's Ruklu filling in for Wamsi today. I have two questions, one for Rajiv. When you look at the rest of fiscal twenty twenty six, how do you see the pipeline of large deals and the impact from that? And you talked about a growing proportion of revenue from the third-party OEM partners. So Rajiv, what percent of revenue this year is coming from those third-party OEMs? And can you give us any updated expectation for revenue from Dell and Cisco specifically? And I have a follow-up for Rukmini. Rajiv Ramaswamy: Okay. So first on the large deals, second on the OEM. So look, I think we continue to see our share of large deals. At any point in time, we have a pipeline where we have a a good number of large deals with you know, this uncertain timing. And when you have these deals, larger deals, it takes longer to to to really prosecute them and a little less clear when. Right? So we don't factor in all those deals into, you know, a forecast about some likelihood of some subset of them hitting. I would say we're seeing quite you know, it's a good mix. Right? We're seeing you know, we did more million-dollar deals last year. Than the prior year. We probably will do more this year as well as we go through the year. It's still early in the year. So we certainly have the pipeline. Of several deals out there that we should be we are working currently. On that front. Now on the OEM side, I will say that we haven't broken it down yet. In terms of what percentage of revenue is coming from it. But it's clearly growing. Right? You know, Cisco has now been out there for a while, and they are continued to ramp along nicely. Dell is still early in that in that life cycle. But I think if we've now got PowerFlex on, we will have PowerStore on sometime next summer. And so in general, our alignment with Dell is getting better. And and so I would expect that to continue also growing. And we've also had historically Lenovo, although they're a smaller OEM partner. That's been there for a while, it's business as usual on that front. But I would say I would expect the mix of Cisco and Dell both to grow for us over time. We haven't quantified it yet. Ruplu Bhattacharya: Okay. Thanks for the details there, Rajiv. Rukmini, one for you. Sounds like there's a structural change in the business where more bookings going forward will have future start dates. I guess the first thing is like how what is giving you that confidence that this is a permanent change and not something just specific to the near term or fiscal twenty six. So am I reading this correct that this is a structural change? And then second and part of this question is, on Slide 10, it says that we're going to balance prudent investments for continued growth with a focus on margins. And you're keeping free cash flow more or less same up $10 million at the midpoint. Is there any risk that investing less now can hurt future revenue growth? In outer years. So if you can just comment on that. Rukmini Sivaraman: Thank you, Ruplu. So on the on the first point you made in terms of the the change to future start date and why we think going to continue. One thing we said earlier was that one of the factors we think that's driving this, right, primary factor has been sort of this growth in Broadcom migrations. And we're finding that these customers they want to commit with us. They often need more flexibility, though, to help them match their migration timelines and so on. And so that dynamic, as we've talked about for a while, we expect those migrations to be sort of a multiyear journey for us. And so on. And we're always looking to balance customer needs with our own business goals, and so we'll continue to do that. The reality, though, is for some of these migrations, typically the larger ones, where the customer might say, look. I need these licenses over time rather than all up upfront depending on their own migration timeline. So that's the underlying dynamic around that. Second, to your question around we're keeping margins the same margin guidance the same margin guidance same as before, while we've taken revenue down relative to before and same on free cash flow. I think when we take free cash flow up, slightly, I think, relative to last what we told you last quarter. So if you think, would say, right, on the operating margin side, we we do wanna balance those two things, which is continuing to invest, investing prudently in growth while looking to to grow margins over time. Would say a few things on this. So one is with revenue getting deferred or shifted out of '26, there's some commission expense that gets deferred with that. We're also seeing slightly higher partner payments. These nonrecurring partner payments we've talked about before, they're slightly higher than what we had assumed when we gave you the guide three months ago. And then overall, we're always looking to manage the business efficiently. Right? So when I think about all of that, we feel good about the balance between investments and growth. And then, again, on free cash flow, the one other factor I'll say on free cash flow is that while we're seeing this more revenue, shift out of 26, we still typically invoice on bookings and collect cash upfront. Regardless of when the license deployments occur. So that's another thing to keep in mind when you think about free cash flow and cash collections. Rajiv Ramaswamy: Let me add one more thing, Rupini. Sorry. On that front. So when you talk about structural change, to the business, I think one element of it is structural, which is you know, more of our business is going to our OEMs. Like Cisco and Dell. And there is a structural of that in the sense that in that case, what we do is we give them our software, and then they put it along with the hardware. They create an appliance kind of model, and then they sell that. Right? So for us, fundamentally, at that point, we only recognize revenue when they ship. Right? We don't recognize revenue when we just provide the software to them, but only when they ship to their customers. So that, I think, do expect that side of the business to continue growing. Right? And that means that from the time we get a booking to the time that, you know, they we we could get revenue for that, I think. Is is gonna be fundamentally delayed. Right? And and so the more the mix the more of that we'll see. Ruplu Bhattacharya: Okay. Okay. Thanks for all the details. Operator: Thanks, Rupul. Thank you. Our next question comes from Nehal Chokshi with Northland Capital Markets. Please proceed. Nehal Chokshi: Thank you. I do have a couple of questions. First one, Rukmini, you said that bookings came in ahead of expectations. Did you actually state, how much were bookings up on a year-over-year basis? Rukmini Sivaraman: We did not. No. We don't typically report or give you specifics on bookings. So we did not call that out specifically. Nehal Chokshi: Okay. And so that that's why you were talking about the different components of bookings, those being RPO and cancelable cancelable orders as well then. Is that correct? Rukmini Sivaraman: Yes. So just to be clear. Right? So RPO, it it captures a lot of things. RPO has deferred revenue, which is obviously coming as a waterfall from prior periods as well. The majority of deferred is is support. Ratable piece of our business, and then there's some that's licenses that are coming from prior quarters, and that's proportion that's increasing. And then we also have in RPO, the other component of our RPO is noncancelable backlog. And what I think what I was answering the prior question or the one before earlier from Jim, think, was around the fact that RPO does give you a sense of what is expected revenue in future periods. We give you CRPO as well, which is next twelve months. That is coming off of either the balance sheet or from this noncancelable So it does give you there is embedded in there is Some proportion of the bookings that we had in Q1. But did not yield revenue in Q1. Nehal Chokshi: Okay. Canceled backlog, that that that you have said something about cancel backlog in one of the other questions. What what did you actually specifically say about that? Rukmini Sivaraman: Yeah. I was just saying that there's a that's a there's a small component of cancelable backlog. Relative to the RPO number. It's small. That, we don't put out. But that's also eventually, most of it does turn to revenue over time. Nehal Chokshi: Understood. Okay. Rajeev, for you, in your best estimate, what market share do you think Nutanix is picking up of VMware migrations? Rajiv Ramaswamy: Look. I that's a little hard to estimate. Right? I mean, if you look at the customers who are doing the migrations, I mean, the choices are us, Red Hat, and then I would say public cloud, which is being I I would say a minority. Right? And I can give you some qualitative color. Quantitatively, it's very hard for us to to really say. I would say, look. I mean, the proof of the pudding is we've got 2,700 customers plus who we we added last year. And we added another product six forty or so this quarter as well on top of that. And those are all customers who are doing migrations. You know, perhaps the one that might be pertinent is Red Hat. Right? And if you look at it, I think we are winning a good chunk of business of compared to Red Hat in terms of these customers migrating. Red Hat tends to be playing primarily where containerization is the main thing. Our platform is very solid when it comes to virtualization, the ability to run mission-critical workload, and the flexibility to to provide you know, both virtualization virtualization solutions as well as container solutions. We see some significant events, some of which are public. Right? So take finance informatic as an example. Large bank in Germany, all the regional banks, And, you know, for example, they had IBM and Red Hat a significant existing deployments, and, of course, big VMware shop and migrating their VMware workloads over to Nutanix. And that's just one example of a win. So I don't have an exact quantification to your question on the number, by the way, but we do believe you're winning a significant portion of those migrations. Nehal Chokshi: Okay. And then, you know, with respect to this container versus mix environment, is it fair to say that increasingly organizations are looking for the modernized container only solution? Or is it more organizations are looking for a mixed solution? Rajiv Ramaswamy: Most companies that we talk to, most customers that we talk to have a mix with the majority of the rest is still very much virtual machine-based. And the newer stuff everything that's new, net new being built is being built on containers. So almost everybody we talk to at least, it's a mixed environment. With more of the existing asset being virtual machine-based. Okay. Nehal Chokshi: Thank you. Operator: Thank you so much, Suzanne. As a reminder, ladies and gentlemen, please leave me your questions to one and one follow-up. Our next question is from Jason Ader with William Blair. Please proceed. Jason Ader: Thank you. Good afternoon. So I think, Rajiv, what you guys have been saying is that the push outs on the license start dates are due to the complexity of migrating off VMware. It just takes a while. And we kinda knew that, but you you've been doing these migrations for almost two years now. I guess, why do you think this push out issue didn't pop up sooner What what what makes this current time period maybe special? Forget about the OEM part of the business, but just on the the flexibility question, do you think it's it's a budget issue, a macro issue, or or some other issue? Rajiv Ramaswamy: Yeah. First of by the way, to your point there, it's not entirely new. Right, Jason? We seen this in the past too. We've talked about how you know, on on some prior large deals, we've had to provide this kind of flexibility to to align with the migration timelines. Now I think in the past, there were a smaller portion. Right? Of our business. Now we've got, you know, growing set of broad migrations. Right? So and and as as that grows again, we're finding that again. There's more of this that that requires that flexibility. And that's really, I think, is the is the the infection that we saw. And and we saw this very late this Q1 as well on this front. So would say it's just the fact that we have more of this coming. Now. That's the primary driver. Rukmin, do you wanna add any color on this one? Rukmini Sivaraman: I agree, Rajeev. I think you covered it. Jason Ader: Okay. Great. And then as a follow-up, for you Rajiv also, One of the comments we've heard from the channel is that you know, when people compare the renewal from from Broadcom compared to the the upfront pricing, including hardware. From Nutanix, it's, you know, it's not that different. And I know that you guys you've talked about this. But I guess the question is, should you be more aggressive on the upfront pricing to win business? And then is it is it is it gonna be more problematic on on that delta between, you know, the renewal for the customer versus, you know, the the full hardware refresh with the NAND pricing going up as much as it is. So that I guess that's that ties into the supply chain. Question that we discussed earlier. How how do you think about sort of upfront pricing and how that might change over time? Rajiv Ramaswamy: No. That's a very good question. Right? And I think and and a lot of it is also do they need to buy new hardware or not? Right? Tied to that. Because, you know, look at it from a software perspective, we're not leading with price. But we aim to be very, very competitive, right, with Broadcom. Otherwise, we will not win the account. And and especially when we are landing a new customer, I think we will be aggressive. Now I think the big barrier is they do need new hardware and they have to purchase new hardware. Now there again, that's why this hardware timing. Timing hardware refreshes it's it's a very important question. Right? So now of course, so on our part, we've been doing a lot to try to get our software to work on as much of the existing hardware. That our customers have, whether it's external storage, with Dell and Pure or even know, their existing servers that that may have running, for example, VMware vSAN or their their equivalent of hyperconverged. So so we've been trying to reduce that hardware portion of the outlay for the customer. And that will help us also for the more that we're able to do there, the the easier it is for us to insert. So those dynamics haven't changed really I think on our part, we've been working to again again, make our software, you know, more broadly applicable so that our customers don't have to go reinvest in hardware. Now when they do reinvest in hardware, by the way, I think the other point that we should not forget is that a lot of the VMware deployments 80% of it is still three-tier storage. And if they move from three-tier storage to HCI, including the hardware, there is a significant benefit. As long as they're ready to go replace their hardware, there is a significant TCO benefit there too. So so we monitor this. We look at every deal. We look at the of the customer and then decide our strategy there. Thank you. Thanks, Jason. Operator: Thank you. Our next question comes from the line of Mike Sikos with Needham. Please go ahead. Mike Cikos: Hey, thanks for taking the questions here guys. I just have a quick one and then a follow-up. I wanted to add, though, just to make sure I was clear on it, for the first question. When I look at some of the guidance commentary here, and specifically the second point around the growing proportion of business through third-party OEM partners. Is the point here that you're dependent on those partners as far as their timeline to ship those appliances. Or does that default back to, again, the flexibility that these customers are requesting? And the the the heart of the question is, is there anything you can do on your side to help those OEM partners move boxes out the door? Rukmini Sivaraman: Yeah. I'll start, Mike. It's more the you know, the the point you made about our revenue recognition is tied to when they ship the hardware, at which point, you know, then our our license provisioning is tied to that. It's less so, we believe, tied to this customer dynamic, which is why we call them out separately. Mike. It's more the ability of the OEM partner to to get the the to get the hardware shipped from their side. Then our license deployment is kinda linked to that, leading to our rev rec. Rajiv, do you wanna add anything to that or, you know, on what we can maybe help them with? Rajiv Ramaswamy: In terms of the I mean, they're not really. Right? I mean, we don't quite control when they ship Right? So it's up to the the OEM partners to to ship their hardware. And so we don't quite control that. Mike Cikos: Understood. Thanks for the the additional color there. And then for the I was just hoping to ask an Ravini, I understand there's a complexity of layers as far as how you put the guidance out there. But if I look at some of the the the delta here that we're talking to between the bookings, and the timing of revenue how much of the if I look at the full year guidance reduction here of about $80 million at the midpoint, How much is based on what we saw exhibited in Q1 versus what is now expected to transpire as we get to q's '2, three, and '4. I I just wanted to see if there's any way to triangulate or conceptualize the different moving pieces there. And I know that's a complex one, but I again, just trying to get little bit more of a firmer understanding. Rukmini Sivaraman: Yeah. So I think what we said for Q1, Mike, was that you know, if our assumptions had played out, as we had expected from when we gave you the Q1 guide. That our revenue for Q1 would have been above the high end of the range. And in in instead, it was $6.71. Right, which is what the reported revenue number was. So and and then that gives you a, I guess, a bit of sense of much we were expecting in in q '1 before we saw this late in quarter dynamic that we've that we've talked about here. And so that's maybe I'll leave it there, Mike. We're not sort of breaking it down more than that, right, in terms of specific quarters or so on. And then the other comment I made, I'll you know, say again is around seasonality, like, first half, second half. Where for fiscal year twenty six, if you take the first half Q1 actuals, q '2 guide, and then compare it to what second half will be, that mix is no. It may not meaningfully different from what we saw. Last year. So that would be the one other way to think about the contributions. Mike Cikos: Very helpful. Thank you very much. Thanks, Mike. Operator: Thank you. Our next question comes from the line of Ben Bolling with Cleveland Research. Please proceed. Ben Bollin: Good afternoon, everyone. Thanks for taking the question. Rajeev, I I think you've touched on this a couple of times. Indirectly. I'm I'm interested your thoughts. On the progress you're making with large customers in making this transition from Broadcom to Nutanix. What you're doing to make that process easier, either you know, reducing the duration of the POC or aiding in the reengineering and the replatforming and the training. You talked about the hardware relationships. Some interested in your thoughts on some of the things you're doing to improve that process or make it easier for customers. And then I have a a follow-up. Rajiv Ramaswamy: Yeah. I mean, it's a very good question. And these large larger customers tend to have more complex environments. Right? So this typically, if you wanna go win them, there's, of course, a POC phase. And we do actually a pretty good job with the POC. It's not really a technical issue. Right? So the POC is rarely actually sticking point. So we we get through that usually easily. Num There are all these other factors that come into play. Right? The commercial relationship and the dependency that they have. Potentially across multiple products with Broadcom. Right? That's a that's a big dependency. The the hardware piece, which again is you know, we try to do, you know, support as much and more of their hardware as we can. So that they don't have to go to fresh hardware when they switch to us. The third thing that we've been working on, of course, is making sure that we can support the baby of applications that they have. Now I would say this is kind of the eighty twenty rule. We support the vast majority of applications in being certified on a hypervisor. There's always gonna be maybe a handful of outliers. That aren't fully supported. I'll give you one example. This is Cisco's unified communication appliances. And and and those until recently, were not they used to work on our platform. But they were not officially certified by Cisco. And so customers would be reluctant to run those on a Nutanix platform. But now it's certified. Right? So we are working on getting it certified Cisco officially said they're certifying it now. So that's a barrier that we have to overcome in some cases for specific applications. Then, of course, the migration itself in terms of professional services required. Almost every one of these larger customers needs a a project team to go help them with their migration. So we have we have that. And then, of course, for the larger deals, we also have a a deals, per team that looks at all of these aspects in terms of putting together an appropriate commercial proposal. Now that said, Ben, for the very largest customers, we typically tend to find insertion points as opposed to trying to do complete pro comp takeouts. Right? So we try to find places where we can actually they can use our solution for, say, specific workload specific use cases. And for example, we have a pretty good database solution. We have a good Kubernetes offering. So these are things where I think we try to differentiate and and also try to get in with a subset of applications. And so that's, I think, typically what we do. Then, of course, last piece, I would just say we go through security audits, and we've gotten pretty good at doing that well and carrying that across through. So we have one fair share of what I would call, you know, certainly Fortune 500 customers. I think as you get to the Fortune 50 at the very top of the pyramid, it's it's very hard to do a full displacement. Right? And like I said, those would be partial entry points for specific workloads. Okay. Ben Bollin: Okay. That's really helpful. And I guess the follow-up would be when you look at the enterprise footprint you are working with, obviously, AI is soaking up a lot of mind share and and dollar share. I'm interested how you think enterprise investments in AI may or may not be influencing your opportunity to go out there and capture bigger footprint. You know, they're trying to do too much at once. They gotta pick their priority. Just how you think about that. Thank you. Rajiv Ramaswamy: I mean, it's a very fair question, Ben. Mean, almost everybody that we talk to has got AI at the top of their minds. But I would just say, that it's not I mean, the vast majority of our customers are, I would say, more experimenting with AI right now than really deploying it at some massive scale. There are exceptions. There are some subset of customers that are, you know, further along the journey. But most of our customers are still very early, so it's not like they have devoted the bulk of their AI as they have spent. To AI. And so we haven't quite seen that yet. Our subset of customers. And keep in mind, our customers are in the AI native companies. Right? They are the typical, you know, industrials and financial services and and manufacturers and retailers. Who are all wanting to use AI. But still fairly early in their adoption. Ben Bollin: Thanks, Rajiv. Operator: Thank you. One moment for our next question, please. And it comes from Param Singh with Oppenheimer. Please proceed. Param Singh: Hi. Thank you. I really appreciate you taking my questions. I have a couple. So, Rajiv Rukmini, and and sorry to harp on, again, on the migration piece, but you know, really wanna understand the impact. Right? I would have assumed that, you know, with migrations, you'll probably have larger deal sizes. Because migrations from VMware are much bigger. So that should layer on and impact your RPO in a much more positive way rather than just a seasonal you know, impact to RPO this current quarter. We really haven't seen that please if you could help me understand that. And and if it is true that, you know, you are gaining all these migrations, I would assume since migrations take multiple years, you get more and more migrations, your revenue would technically start accelerate into next year. Right? Like, this year's revenue to next year. Plus whatever else you get. So you would you you will see an accelerating trajectory to 2027. Am I wrong in this? Rajiv Ramaswamy: Yeah. So let's first start with the first question, Param. Thank you for those questions. So on on the migrations, you're right that, you know, in general, it's for the typically for the bigger ones where they will say where customer might say, look. Let's can I have these licenses phased out over time versus all upfront? And so what we're saying is that in Q1, we did see bookings come in slightly higher than our expectations. And the the mix of orders that came in with these future start dates that we saw late in Q1 meant that more of that revenue got pushed or shifted out into q q two and beyond than we had previously. Expected. And so so that's the point on around just migration and so on. Now if you look at I think you were trying to tie that to RPO. And so if I look at RPO, like I said, includes, you know, revenue waterfall, which is pretty standard. Right? And you can see in the balance sheet. And it also includes this noncancelable backlog, which what I said earlier was that in Q1, seasonally, you do expect that portion to to be lower quarter over quarter. And that's what we saw in Q1 as well. And if you look at RPO growth, it's quite significant year on year. time. Which is which is a good thing. Right? And when you look at total RPO Mhmm. Growing meaningfully over So that's, I think, the first piece of the answer. And then I think the second part of your question was around, again, fiscal year twenty seven. And why wouldn't there sort of be maybe an acceleration in '27? I think it's how you'd how you'd phrase the question. Param, so what I would say there, right, like, is look. I think this is if this was sort of a onetime thing, you're right. Then we sort of have some kind of a catch up. And we've talked about, you know, three factors here as we thought about the forward-looking view. One was these migrations. And if we and if we believe as we do that these migrations are going to continue, and we're going to be able to prosecute more against the Broadcom displacement opportunity that we will see more of this sustain. And and we expect bookings to grow as well over Right? So even if you assume that the proportion of orders with which to start date stays the same, and you expect bookings in general to grow over time, land and expand bookings to grow over time, the dollar amount that's getting shifted out, that will be higher than shifted in. Right? So there's a net effect there. That will that will matter in in any given period, including in '27. And then like I said earlier, right, '27 overall revenue will also depend on our booking expectations for '27, which, you know, again, not commenting on today, but we'll we intend to cover some of that in in our investor day. Sure. Param Singh: Thank thank you for that, Rukmini. And really quickly as my follow-up, you know, strategically thinking about this, right, obviously, you know, there's an opportunity to take share from VMware here. Why not be more aggressive for the rest of the VMware business here? Know you're going through a reference architectures. But is there a way to accelerate that? Or or maybe not or you don't wanna compete in that. I don't know how you're thinking about it. On the stand-alone virtualization side and how aggressive you wanna be attacking that market. So anything you could share is appreciated. Rajiv Ramaswamy: That's another good question. I think on the stand-alone virtualization, again, we look. I mean, we have been adding. Right? And we have been investing fairly aggressively to you know, expand the support for third-party storage. Right? So we have now Dell PowerFlex, The number two coming on board very shortly is Pure. We have Dell PowerStore. And, yes, there will be more. Right? Now at the same time, we have to also balance those investments versus investing in our future. Right? Where Kubernetes and cloud native and AI Mhmm. Right, on the other side. So we have to strike that balance. Right? We don't wanna go too far backwards in time. To go support everything that's out there. We wanna support the big ones. And if you look at it, once you've got Dell and and Pure, I mean, that's a big chunk of the market. Right? And we'll probably get the other big ones too out there. So we'll focus on, again, getting sort of the big picture, big ones. Out there, and then not trying to go meet everything. And then also balance it out with investing in cloud native and AI. Param Singh: Understood. Thank you. Thank you so much for answering my questions, Rishi, for Appreciate it. Rajiv Ramaswamy: Thank you, Pam. Operator: Thank you so much. And with that, ladies and gentlemen, we conclude our Q&A session. And conference for today. Thank you all for participating. And you may now disconnect.
Operator: Good day. And welcome to the 2026 Earnings Call. All participants will be in listen-only mode. Should you need assistance, please signal a conference specialist by pressing the star key. After today's presentation, please note this event is being recorded. I would now like to turn the conference over to Kris Newton, Vice President, Investor Relations. Please go ahead. Kris Newton: Hi, everyone. Thanks for joining us. With me today are CEO, George Kurian, and CFO, Wissam Jabre. This call is being webcast live and will be available for replay on our website at netapp.com. During today's call, we will make forward-looking statements and projections with respect to our financial outlook and future prospects, including without limitation, our guidance for the third quarter and fiscal year 2026, our expectations regarding future revenue, profitability, and shareholder returns, and other growth initiatives and strategies. These statements are subject to various risks and uncertainties, which may cause our actual results to differ materially. For more information, please refer to the documents we file from time to time with the SEC and on our website, including our most recent Form 10-Ks and Form 10-Q. We disclaim any obligation to update our forward-looking statements and projections. During the call, all financial measures presented will be non-GAAP unless otherwise indicated. Reconciliations of GAAP to non-GAAP estimates are available on our website. I'll now turn the call over to George. George Kurian: Thanks, Kris. Good afternoon, everyone. Thank you for joining us. We delivered a strong Q2 with revenue of $1.71 billion, up 3% year over year. Excluding the divested spot business, total revenue was up 4%. All flash and public cloud, which address growth markets and carry higher gross margins, made up 70% of Q2 revenue. This shift, combined with our continued operational discipline, has enabled us to drive profitability metrics higher. Our gross margin set a Q2 record and exceeded our guidance range. Both operating margin and EPS surpassed expectations and marked all-time highs. Expected softness in USPS revenue was offset by growth in all other geographies. We saw strong demand for our AI solutions, first-party and marketplace cloud storage services, and all flash offerings. In the age of data and intelligence, customers are choosing NetApp for our unified data platform that delivers exceptional value and operational efficiencies, fueling our success in the face of the ongoing macro environment. In October, we hosted our annual customer conference, NetApp Insight, where we unveiled major advancements to our enterprise-grade data platform, including enhanced AI workload capabilities, stronger cyber resilience, and deeper AI integrations and data solutions with our hyperscaler partners. Customers and partners shared how NetApp is driving their success in the age of data-enabled intelligence. Their feedback and achievements underscore our commitment to innovation and delivering value in a rapidly evolving landscape. We launched AFX, an ultra-scalable, extreme-performance disaggregated storage platform certified for NVIDIA SuperPOD, designed to power demanding AI workloads and AI service providers. AFX seamlessly integrates into an organization's hybrid multi-cloud data estate with the proven enterprise-grade data management and security features of ONTAP. We also introduced the NetApp AI data engine, an end-to-end AI data service integrated into ONTAP. The AI data engine, referred to as AIDE, simplifies data discovery, querying, searching, and analysis. It helps operationalize and scale data pipelines for AI, with integrated data discovery, curation, policy-driven guardrails, and real-time vectorization. This enables fast data access, efficient transformation, and trusted governance. Together, AFX and AIDE transform how enterprise customers achieve positive AI outcomes by accelerating data discovery and simplifying data pipelines while maintaining security, access controls, and data integrity. Native integration with leading AI platforms, including Domino, NVIDIA, and Informatica, enables compatibility with enterprise workflows. Our zero-copy caching and native cloud connectivity help organizations unify data and apply advanced AI capabilities across any site, cloud, or model, speeding time to insight. We also enhanced our rapidly growing Keystone storage as a service for enterprise AI, offering AFX and AIDE under a single subscription for elastic scaling and usage-based billing, encouraging broader enterprise AI adoption. These innovations build on our growing success in AI workloads. In Q2, we closed approximately 200 AI infrastructure and data lake modernization deals across diverse geographies, industries, and use cases. Our massive installed base of unstructured data, advanced data and metadata movement services, industry-leading data security, and unique hybrid multi-cloud capabilities make us the clear choice for enterprise AI. Here's an example of why we are winning in enterprise AI deployments. A global semiconductor capital equipment manufacturer selected NetApp to unify its enterprise AI data foundation across on-premises and cloud environments. Our hybrid multi-cloud data visibility and secure governance drove confidence in the compliance and operational efficiency of their AI workloads. We enable them to create a single searchable view of corporate knowledge across millions of documents, emails, and engineering datasets, providing employees with faster, more accurate access to institutional knowledge. A large amount of AI innovation takes place in the public cloud. ONTAP is the only unified data platform natively integrated in the public cloud, putting us in a unique position to enable customers to leverage any of the major AI models without the complexities of moving data. In Q2, we expanded our native AI capabilities in Azure and Google Cloud, adding to what is already available in Amazon Web Services. Giving customers the flexibility to run AI workloads wherever they choose. Adding to existing multi-protocol support in AWS, we launched support for block storage capabilities in Google Cloud NetApp volumes in Q2. This brings the full power of ONTAP to Google Cloud with high-performance unified storage, integrated data management and protection, and a common cloud control plane. We introduced new capabilities in Azure NetApp files, including single file restore and a flexible service level for independent scaling of throughput and capacity. And in Amazon, FSx for NetApp ONTAP, we announced support for Amazon Elastic VMware service, enabling secure, efficient migration of VMware workloads to AWS. By continuously adding new functionalities to our public cloud storage services, we are broadening our addressable market, driving new customer acquisition, and positioning ourselves for continued growth. This strategy has yielded rapid expansion in our highly differentiated first-party and marketplace cloud storage services, with revenue increasing approximately 32% from Q2 a year ago. In Q2, a leading cloud-based media production company selected FSXN as its standard for file and block storage. In addition to multi-protocol support, FSXN delivered cost savings through storage efficiency, high availability, superior multi-tenancy, and intelligent caching to put data closer to its users. The company believes that FSXN gives it a competitive advantage in optimizing cloud storage and enhancing performance for its customers, creating these capabilities for a key customer win. Customers are choosing NetApp to provide a unified, cyber-resilient, and efficient way to manage their entire data estate. Built for the age of data-enabled intelligence, the NetApp Data Platform redefines what a modern enterprise foundation should be. Unified, enterprise-grade, intelligent, cloud-connected, and ecosystem-ready. We help organizations modernize, secure, transform, and use AI with confidence. Continued strong customer engagement and interest in our unified and block-optimized all-flash storage portfolio delivered 9% year-over-year growth in all-flash array revenue to $1 billion in Q2, or an annualized run rate of $4.1 billion. Exiting the quarter, approximately 46% of installed base systems under active support contracts are all-flash. NetApp helps customers confidently safeguard their data with built-in security through real-time threat detection, protection, and recovery. In Q2, we enhanced the NetApp Data Platform's industry-leading cyber resilience by launching the NetApp Ransomware Resilience Service for both structured and unstructured data. This service is designed to stop cyber threats before they cause extensive damage by proactively detecting data breaches in real-time and providing isolated environments for safe, clean data recovery. Our industry-leading cyber resilience capabilities are helping us win new customers and displace competitors. In Q2, a major Asian life insurance company chose NetApp for its mission-critical private cloud environment, replacing its long-standing storage vendor. Ransomware protection was a top priority, and our ability to provide strong cyber resiliency for critical workloads was a key factor in the decision to choose NetApp. We also announced the latest version of StorageGRID, with new capabilities designed to enhance AI initiatives, improve data security, and modernize organizations' data infrastructure. Many customers begin their AI journey by updating data lake environments, and StorageGRID object storage delivers the optimized performance, intelligent data management, and modern cloud integrations needed to manage massive datasets. In Q2, a leading financial services company selected StorageGRID to modernize its legacy Hadoop environment. With capabilities for a hybrid architecture featuring data durability, a global namespace, robust security, and automated zero-intervention backup and disaster recovery, StorageGRID addresses the company's next-gen AI workload requirements. In summary, strong execution and operational discipline delivered an outstanding second quarter. Our focus on growing markets, all-flash, public cloud, and AI continues to yield top-line growth. The substantial innovation we introduced this quarter extends our differentiation and helps solidify our leadership position as the intelligent data infrastructure company. Looking ahead, we are focused on leveraging our alignment to customers' top data initiatives and pressing our significant competitive advantage. Despite the unsettled macro environment and near-term USPS headwinds, we remain confident that our visionary approach to a data-driven future will enable us to outgrow the market and capture additional share. I'll now turn it over to Wissam. Wissam Jabre: Thanks, George, and good afternoon, everyone. As George mentioned, in the fiscal second quarter, we delivered strong results, exceeding both the midpoint of the revenue guidance range and the high end of the EPS guidance range. Total revenue for the quarter was $1.71 billion, up 3% year over year. Non-GAAP earnings per share was $2.05. Excluding the divested spot business, which generated $23 million of revenue in the year-ago quarter, total revenue was up 4% year over year. The effect of foreign currency exchange rates was favorable to revenue growth by approximately one percentage point year on year, while it was immaterial relative to guidance. Looking at revenue by segment, Hybrid Cloud revenue of $1.53 billion was up 3% year over year, driven by product support and Keystone. Keystone continues to show great progress with growth of 76% year over year. Public Cloud revenue of $171 million increased by 2% year over year. Excluding spot, public cloud revenue was up 18% year over year, driven by strong demand in first-party and marketplace storage services. At the end of the second quarter, our deferred revenue balance was $4.45 billion, up 8% year over year and 7% year over year in constant currency. Remaining performance obligations were $4.9 billion, growing 11% year over year. Unbilled RPO, a key indicator of future key revenue, was $456 million, up 39% year over year. Moving to the rest of the income statement, please note my comments will be related to non-GAAP results unless stated otherwise. Gross margin for the fiscal second quarter was 72.6%, above our guidance range. Sequentially, gross margin was up 1.5 percentage points. Gross profit was $1.24 billion, up 4% compared to Q2 2025. Hybrid cloud gross margin was 71.4%, up 1.4 percentage points sequentially due to product gross margin improving by 5.5 percentage points to 59.5%. Our support business continues to be highly profitable at 92.1%. Professional Services gross margin was 30.3%, improving 40 basis points sequentially, driven by higher Keystone revenue mix. Public Cloud gross margin was 83%, up nearly three percentage points sequentially and over nine percentage points year over year. Operating expenses of $707 million were flat sequentially and down 2% year over year despite the unfavorable effect of foreign currency exchange rates. Operating income was $530 million, up 12% compared to Q2 2025. Operating margin was 31.1%, up 2.4 percentage points year over year, driven by higher revenue and gross margin combined with lower operating expenses. Earnings per share was $2.05, growing 10% year on year. Both operating margin and EPS exceeded the high end of our guidance ranges. Our results demonstrate strong execution on key growth opportunities in our flash, public cloud, and AI, as well as continued focus on operational discipline. Cash flow from operations was $127 million, and free cash flow was $78 million. During the second quarter, we returned $353 million of capital to our shareholders, with $250 million in share repurchases and $103 million paid in dividends of $0.52 per share. Q2 diluted share count of 202 million decreased by 8 million shares or 4% year over year. At the end of the quarter, cash and short-term investments were $3 billion, and gross debt outstanding was $2.5 billion, resulting in a net cash position of approximately $528 million. I'll now turn to non-GAAP guidance starting with Q3. We expect revenue of $1.69 billion, plus or minus $75 million. At the midpoint, this implies a growth of 3% year over year. Excluding the divested spot business from the year-ago comparison, our revenue guidance implies a 5% growth. We expect Q3 gross margin of 72.3% to 73.3%. Operating margin is anticipated to be in the range of 30.5% to 31.5%. We expect EPS to be between $2.01 to $2.11, with a midpoint of $2.06. Turning now to full year 2026. We continue to expect fiscal year 2026 revenue to be between $6.625 billion and $6.875 billion, which at the $6.75 billion midpoint reflects 3% growth year over year. Excluding spot, our revenue guidance implies a growth of 5% year over year. Based on our Q2 performance and the confidence in our outlook for the second half, we are raising gross margin, operating margin, and EPS ranges for the fiscal year. We now expect our fiscal year 2026 gross margin to be in the range of 71.7% to 72.7% and are increasing our operating margin to 29.5% to 30.5%. We expect other income and expenses to be approximately negative $15 million. For the year, we expect the tax rate in the range of 20.2% to 21.2%. We are raising our EPS range to $7.75 to $8.05, with a midpoint of $7.90. In closing, as we look ahead to the rest of fiscal year 2026, our commitment to executing our strategy remains strong. We are poised to seize the expanding opportunities in all flash, cloud, and AI and remain focused on consistently delivering exceptional value to our customers and shareholders. I'll now turn the call over to Kris for Q&A. Kris Newton: Thanks, Wissam. Operator, let's begin the Q&A. Simply press star 1 again. Your first question comes from the line of Aaron Rakers with Wells Fargo. Please go ahead. Aaron Rakers: Yes. Thanks for taking the question. I guess the first question would be as we think about the component environment, both from a potential pricing perspective as well as whether or not you might be seeing any kind of constraints. I'm curious to how the company is managing that. Have you leaned in on any kind of strategic purchases? And any thoughts on the duration of those strategic purchases as far as the next couple of quarters? How much visibility do you have on the pricing dynamics underpinning the gross margin outlook? Thank you. Wissam Jabre: Hey, Aaron. Thanks for the question. So on the components, we know we did mention last quarter that we did lock in some prices. And based on that, we do have visibility for a couple more quarters, I would say, at least until the end of this fiscal year. When you look at where we are, obviously, Q2 product margin was slightly better than our long-term model, which is in the mid to high 50%. And then when we look at the rest of the year, we expect product margin or product gross margin to be relatively stable to where we ended in Q2. Looking ahead, if I think of the component pricing, look, this is an environment that could be volatile. And so we're not going to make a call on that. But what we do is we look at various scenarios. We have a very capable supply chain team that has been through many of these past cycles of tight supply and some of the commodities that we buy. With rising cost environments, for instance, we've been able to manage very efficiently over the years, in fact, while also in some cases, growing EPS. And so we will continue to manage our input cost and maintain our supply continuity. We haven't seen any disruptions so far. We heard of any as such. Now ultimately, our goal is really to focus on our total gross margin. And this comes down to the various components of our revenue and the mix. And so there's the rate there and the mix. If we continue to see current levels, let's say, of some of the commodities, in particular, let's say, I know you probably have in mind that one of the things, for instance, is NAND. We continue to see similar levels, we'll probably have a bit of headwind into fiscal 2027 from a product gross margin perspective. But when we look at the mix of the business, going forward, we continue to see high growth in the cloud business, which is now operating between 80-85%. I mean, Q2, it was at 83% gross margin. We continue to see good growth in Keystone. And so the mix is very much favorable to us. The couple of the last couple of points, I would say, as we think through all of this, we're focused on driving growth in gross profit dollars, which is foundational to the profitability engine of our business. And lastly, you know, if we are faced with higher commodity prices, relative to where we are today, we will always reconsider our pricing. Commodity prices are typically passed through for us, and we don't have an issue passing them through. Aaron Rakers: And, Wasson, I appreciate that. That's a very thorough answer. Looking back historically, how quickly could you pass those through? Is that within a given quarter? Does it take a couple of quarters to see that flow through? Wissam Jabre: Look, this is probably more of a hypothetical, obviously. As I said, where we are today, we have good visibility till the end of the fiscal year. But we don't necessarily need a lot of time to pass them through. We can always adjust prices as needed. Aaron Rakers: Thank you, sir. Thank you. Kris Newton: Thanks, Aaron. Next question? Your next question comes from the line of Eric Woodring with Morgan Stanley. Please go ahead. Eric Woodring: Great. Thank you guys for taking my question. Maybe I'm going to ask a similar question to Aaron. And Wassam, that is you're effectively at 60% product gross margins. I know you said we should expect them to be relatively unchanged through the rest of the year. First part of that is just, is this a function of, you know, mix to all flash? Is this still pricing tailwinds? Is this kind of bomb cost down? I'd love if you could just maybe contextualize what the real drivers are of that product gross margin expansion. And then second, I'll just ask both questions at once is, I realize you don't really need to talk to fiscal year 2027, it's too early in the commodity cost environment is quite volatile. But are we kind of at peak product gross margins? Can product gross margins expand from here? Like I just love to understand how you think about the sustainability of where we are even regardless of the memory cycle. Thank you so much, guys. Wissam Jabre: Yes. Thanks, Eric. Hey, look. What I said, yeah, for the rest of the year, we expect product gross margin to be more or less where we are now. We're in the 59%, I think, and change. When we think about the drivers, you know, it's a combination of things. If I sort of look at where we are year on year, for instance, cost is now roughly flattish. And so we are seeing differences mostly driven by mix and pricing. That's pretty much what drives the margin. And as sort of I look forward, obviously, as you mentioned, it's too early to talk about 2027. But I'm gonna talk about, theoretically, how we think of the long-term product margin of our business. You know, we are targeting mid to high 50% margin. And so that's really we are operating a little bit better than that now. But our target is a mid to high 50% because, ultimately, to drive better gross margins for the company, is the mix that's going to be also a tailwind as our fast-growing cloud business continues growing at the high and delivering higher gross margin than the corporate average. This should help us improve on our margins. I wouldn't put a cap on our product margin ultimately, we continue to be very operationally disciplined in how we conduct the business. But I hope this answers your question. Kris Newton: Alright. Next. Your next question comes from the line of Samik Chatterjee with JPMorgan. Please go ahead. Samik Chatterjee: Hi. Thanks for taking my questions. And maybe if I can pivot a bit more to the revenue side. George, you talked about sort of the AI-related transaction or deals that you closed. Looks like 200 versus 125 last quarter. Wondering sort of what you're seeing in terms of trends there. It sounds like an expiration on the sort of headline number of deals you're seeing. And is the AFX solution that you launched at Insights, what sort of customer feedback are you getting? And is that playing into those deals that you're now seeing? I have a quick follow-up after that. Thank you. George Kurian: We are seeing a fairly stable mix of transactions. The volume is growing. The mix has stayed roughly the same, which is data prep and, you know, data lake modernization about 45% of the mix, training and fine-tuning, about 25 to 30% of the mix, and the rest is kind of rag and inferencing. I think you can see the pace of, you know, kind of wins have grown. A year ago, it was about a 100 greater than a 100. Now it's close to 200 or 200 across. So we're seeing the growth in the number of wins. And the mix staying roughly stable. With regard to the AFX platform, listen, we have had a huge amount of interest in it. It's going through customer qualifications. It's too early to say that it's because of the results. In the quarter. It takes a few quarters for a new system and architecture to get qualified, but we're seeing strong early interest in it. Samik Chatterjee: Got it. Got it. And then, maybe a quick follow-up for Wissam here. When I look at the 3Q revenue guide, it's roughly sort of flat, modestly maybe down quarter over quarter. I realized last year you had the same seasonality, but for most of the previous years, prior years, you typically sort of have a seasonal growth from Q2 to Q3. So obviously it's a dynamic macro and you have sort of public sector headwinds, but anything sort of driving this seasonality to be a bit below average relative to your prior years into Q3? Wissam Jabre: So Samik, the really the couple of reasons are pretty much what you mentioned. You know, there's a bit of a dynamic macro. We're expecting our U.S. Public sector business to be slightly below seasonality. Given, obviously, the most recent shutdown in a little bit of time for government to reopen. Having said that, we view these as temporary and long term. We expect that business to get back to normal levels. Samik Chatterjee: Got it. Thank you. Thanks, Mick. My question. Kris Newton: Thank you, Samik. Your next question comes from the line of David Vogt with UBS. Please go ahead. David Vogt: Great. Thanks, guys, for taking my question. I'm going to roll them into one. So maybe George and Wissam, when I think about kind of the demand drivers going into the second half of this year, and I think you said you still expect federal to be sub-seasonal. How do we marry that sort of outlook and then going into 2027 with kind of how you're thinking about inventory and purchase commitments because your inventory on the balance sheet is still relatively modest doesn't seem like you took in a lot of finished goods. From my quick look. I'm just trying to think how we should think about marrying maybe a recovery and of the verticals like U.S. Federal next year. Hopefully, that's behind us. And how you're thinking about adding purchase commitments and working capital to support the business next year? Thanks. George Kurian: I think maybe I can start and then Wissam can add color. I think, first of all, if you look at the second half implied growth rate, it is up if you look at x spot relative to the first half. So we are seeing some acceleration despite the U.S. public sector headwinds in the second half of the year. We see the, you know, the non-U.S. public segments had a strong result in Q2. Our flash business accelerated from 6% to 9% in the quarter despite a tough compare a year ago. So we feel good about momentum. We are aligned to what customers are spending. Despite the choppy macro, customers are spending on AI projects, on data infrastructure modernization to get ready for AI. They are implementing additional cyber resilience protection. We feel good about our alignment to customer spending. And then I think the third thing is that the faster-growing parts of our business are now a bigger part of the overall number. Cloud and flash are now 70% of the overall number. The slower, you know, the parts of the business that are not growing, are both smaller and also stabilizing more. And so that gives us belief that second half, hopefully, once U.S. public sector gets clarified, we should have a strong set of results going forward. Wissam Jabre: Yeah. And, David, with respect to purchasing commitments, look, as I mentioned, we have good visibility till the end of this fiscal year and we would be opportunistic as we go forward. We will be obviously looking at fiscal 2027 and we enter the year, we would want to be able to have good visibility and in many cases secure whatever would he. And so we won't hesitate to take the right actions. To make sure we protect our business and we have the supply that's needed. David Vogt: Wissam, can I follow-up or full year kind of purchase commitments given the environment? Like what's your philosophy going into next year? Wissam Jabre: I would say it all depends on what buying and when. And so there isn't really one answer that fits all. We will be very dynamic. We'll make decisions very fast. But as I said in my earlier remarks, we have a very capable supply chain team. We the commodities and we don't hesitate to take action as needed. We do have a strong balance sheet. And if we need to take any specific action to protect our supply or to sort of lock in good prices, we won't hesitate to do that. David Vogt: Great. Thank you. Kris Newton: Alright. Thanks, David. Your next question comes from the line of Krish Sankar with TD Cowen. Please go ahead. Krish Sankar: Yes, hi. Thanks for taking my question. The first question, George, is for you. You kind of spoke about the 200 AI deals that you closed in the quarter. What is the average size of these deals? And also, where are we in the pilot to production journey for enterprises of AI? Is there a way to think about that into 2026? I have a quick follow-up. George Kurian: Listen, the deal sizes are all over the map. I think that there are some that are smaller in proof of concept, and there are others that are in scale deployments that are much larger. So I would not share a particular number related to the average deal size. It would misrepresent the answer. With regard to the, you know, broad themes, I think, first of all, you know, data lakes and data prep are usually prior to scale deployments. They are in the get ready to use AI, bring all of my data together. I think fine-tuning and inferencing are at various stages of the, you know, kind of proof of concept to production deployments pipeline. I think if you look at the industry, life sciences, financial services, some parts of manufacturing, and public sector are areas where we see AI being broadly adopted. With the most advanced use cases in life sciences, and I think that you know, the adoption use cases depend on industry. Krish Sankar: Got it. And then as a quick follow-up, Peter, for you or Wissam, you spoke about the first-party hyperscale services demand was very strong last quarter. Can you just quantify how much did that grow last quarter, that services business? Wissam Jabre: The first-party at marketplace services business grew 32% year on year. Krish Sankar: Great. Thanks, Josh. Kris Newton: Yep. You're welcome. Thank you, Krish. Next question comes from the line of Steven Fox with Fox Advisors. Please go ahead. Steven Fox: Hi. Good afternoon. I just had one question. Given all the supply shortages that you're talking about, which seem to have accelerated, I guess, in the last several months. And I understand that you've taken some tactical moves to secure supply. Why do we think or is there a risk, I guess, that you run into next year sometime? Not saying first quarter or second quarter, but is there a risk that at some point that the lack of supply hurts overall demand, whether because of overall price of product or just your availability to ship? Thanks. George Kurian: I'll just clarify the comment by saying we did not suggest that we have any supply shortages. We said that we have secured supply commitments and pricing through the end of the fiscal year. And we'll take appropriate actions to guarantee supply across a broad ecosystem of suppliers through the next fiscal year depending on what we see. Steven Fox: Okay. So that you're confident that the price whatever price you're talking about a year from now, George, is sustainable in the marketplace, I guess? George Kurian: Listen. There's a lot of puts and takes in the bill of in our products. And so and we have a broad ecosystem of suppliers. So we work with them both to look at, you know, a variety of different price points and offering. And we'll have the right mix. As we said, you know, the historic pattern of this industry is that when component prices, commodity prices go up, there are pricing actions taken to share some of those price increases with. And if it reaches that point, we will have we have the experience to do that. Steven Fox: Great. Thank you for the color. Kris Newton: Thank you. Thanks, Dave. Your next question comes from the line of Tim Long with Barclays. Please go ahead. Tim Long: Thank you. Two if I could as well. Hate to kill the commodities here, but just curious, a lot of talk about NAND, but HDDs are tight and going up as well. So is there what's the impact on the business of QLC being used more than hybrid or maybe more than TLC? Any moving parts that might actually benefit the move towards all flash, number one? And then number two, the cloud revenues have been pretty consistent, high teens x spot. George, you mentioned a lot of new offerings on the big cloud players. Could you just talk about that kind of xSpot growth rate? Do you think that high teens is sustainable? Or can some of these newer offerings help accelerate that number even though the base is fairly large? Thank you. George Kurian: Yeah. On the first question, listen. HDDs actually performed well for us this quarter. It performed, you know, in my expectation, better than we had planned. And so we are seeing a broad range of use cases for these products. We don't see that one type of technology replaces the other. There are use cases for TLC, QLC, and HDDs, and we are seeing that pattern in our business. I think with regard to your question on cloud, listen, I think broadly speaking, we are super positive. About the growth of our first-party and marketplace cloud services business. They have been kicking along nicely north of 30% representing strong customer demand for our differentiated. I think that, you know, the scale of the business, if you look at the Q2 quarter on quarter growth, it was the highest quarter on quarter, you know, incremental revenue the history of the cloud business. So we feel really strong about that. And broadly speaking, we have a really good set of tools for enterprise workloads on the cloud. The next big push is to capture the AI and data-intensive workloads on the cloud. And so you'll see us bring innovations in the market. We already talked about some of them, and you'll see a lot more of that over the next, you know, six to twelve months. And so super excited. This is really about scaling the go-to-market. It is almost, you know, we can bring on as many clients as we want. It's really bringing effectively scaling go-to-market motion. For our cloud offerings. Kris Newton: K. Thank you. Your next question comes from the line of Simon Leopold with Raymond James. Please go ahead. Simon Leopold: I wanted to see how you thought about your opportunities to win business with some of the sovereign or neo clouds who are not necessarily hyperscale and, you know, building their own storage solutions. How do you see that fitting into your strategy? And what kind of opportunities have you seen so far there? George Kurian: Yeah. We are part of a large number of sovereign clouds. Across the globe for many, many years. With regard to their AI landscapes, we have mentioned, you know, sovereign AI wins. Solution. We have expanded the range of offerings with the AFX that allows us to participate in a broader range of, you know, footprints within those, you know, sovereign AI cloud. And we are bringing more innovation to the market, you know, over the next few months. So stay tuned. Simon Leopold: And how do you think about the competitive landscape in that application and broadly the AI opportunities? George Kurian: I think that as those sovereign providers look to serve enterprise clients, with AI workloads, all of the value that we have both in terms of the differentiated capabilities around security, multi-tenancy, data protection, hybrid landscape, play to our advantage. We are seeing some of that momentum. With the introduction of the AFX. People have been super interested in our ability to serve those new use cases that those AI cloud providers are trying to go after. Kris Newton: Thanks. Thank you, Simon. Your next question comes from the line of Jason Ader with William Blair. Please go ahead. Jason Ader: Yes. Thank you. Good afternoon. Wanted to first ask just on the performance in the quarter. You had a nice roughly $20 million beat. And then you reiterated for the year. So I just wanted to understand why you didn't flow through the beat. Is it just a little bit extra conservatism? Based on public sector or supply chain or any other factors? George Kurian: Yeah. I mean, I think we saw, you know, in the quarter, some really strong we talked about large deals. We had a, you know, good set of those that helped offset the really steep decline in the U.S. public sector business. We had not anticipated when we guided the quarter that USPS would suffer such a long shutdown. And I think as we look out to the second half of the year, if you look at the overall guide for the second half of the year ex spot, it actually is an acceleration year on year from the first half. But you know, clearly, we want to have more line of sight into how U.S. public sector plays out. As Wissam mentioned, it takes a while for the governmental agencies to get back to procurement and spending, and so we're being a tad cautious about that. There are no implications from the supply chain in our guidance. Jason Ader: Okay. Great. And then just a quick follow-up, on Keystone. Don't think that's come up in the Q&A yet. Know, you've been in this space for a long time, George. I mean, do you feel like we're hitting some type of an inflection in the storage as a service model? Maybe it's not an inflection. Maybe it's just sort every year, it's going to get bigger and sort of be more of a slow burn. But it does seem like that part of the business is incredibly strong, and we've seen strength across other suppliers as well. So do you think that this is just going to be more of the norm in the storage market over the next decade or so? George Kurian: I think this is, you know, a new way for customers to buy infrastructure. I think it is driven both by maturity of the offering as well as customers, you know, kind of maturity in using these business models coming from the cloud. Right? So they've learned how to buy infrastructure and a consumption model from the cloud. And so we see that growing as a part of the overall business. You know, like all things, enterprise infrastructure is a very large market. And so it will grow as a part of that market. We're excited to lean into that trend. I don't think the whole market switches overnight. Nothing ever happens that way, but it'll grow as it'll grow faster than the rest of the enterprise infrastructure buying models. Jason Ader: Thank you. Kris Newton: Thank you, Jason. Your next question comes from the line of Ananda Baruah with Loop Capital. Please go ahead. Ananda Baruah: Yes. Thanks, guys, for taking the question. George, with video, such a big theme at Insight, let me just since we have you take the opportunity to ask you anything notable or interesting on video that you saw over the last ninety days that you're seeing emerge? And I guess, video specifically, but unstructured generally? You know? In your customer base or in some of the proof of concepts. Thanks. I have a quick follow-up too, if I could. Thanks. George Kurian: Yeah. Unstructured is clearly the place that customers are spending time organizing. We talked about the use cases where, you know, large semiconductor equipment manufacturer brought together millions of documents across a variety of applications to better understand what their engineers and their operations teams were working on so that they could, you know, kind of continue to optimize yield and, you know, efficiency in their business. We see that more and more across organizations. I think with video itself, you know, we talked about the content production house. That is using AI to build better, more enriched experiences for their digital clients. And so you're seeing that in certain use cases. We are also seeing the use of multimodal applications starting to grow. And then video analytics, for example, in weather forecasting, weather analysis, things like that. And so it's growing. I wouldn't say it's been the dramatic inflection, but multimodal is growing. We are seeing demand from customers for support for more complex multimodal language models, for example. Ananda Baruah: That's helpful. Thanks. And just a quick follow-up on memory. The hard drive makers seem, as we go through next year, like, they're pretty intense. On mixing up pretty quickly from 20 TB drives to 30 TB drives. Is that consistent relatively speaking with what your customer base is looking for also? I guess I'm wondering if that's organically in tandem with what your customers also would want. Thanks. That's it for me. George Kurian: I think broadly speaking, customers are looking for aerial density improvements from above, you know, all of the silicon. We work with our supplier ecosystem to qualify different media sites and density points. And we'll do the same. We follow customer demand. We look at what the supplier ecosystem is telling us. Broadly speaking, you know, performance, cost, and density are the key drivers of new silicon adoption. Kris Newton: Thanks, George. For that. Your next question comes from the line of Louis Miscioscia with Dowry Capital Markets America Inc. Please go ahead. Louis Miscioscia: Hey, George. On the latest earnings call, you'd seem to be a lot more encouraged about AI. And, obviously, you have a lot more wins this quarter. And I guess, you sort of were asked this question before, but let me just try again. Obviously, there's been a massive growth in many areas, mostly in servers, but storage in general hasn't really seen a big, big pickup from AI. So when do you think inference applications really start to create more data? That would then drive material new revenue for you? Do you see it as maybe first half calendar 2026, second half? I mean, I assume at some point it has to hit. George Kurian: Yeah. I think we've always set compute and network build out would be both bigger and earlier than the storage build out. I think it is because the training of large language models and the algorithms that are being used for AI does not require a lot of storage. Right? Nobody is creating a second copy of all the Internet data to train OpenAI. And so that build out, of course, will be bigger and earlier than storage. I think as we said, storage is 80% of the storage use is actually from inferencing. So as inferencing becomes a bigger part of the overall AI landscape, you will see more storage consumption. I think we are seeing it in our business also in the data lake, data modernization business where people are building large multi-terabyte repositories to bring all their data together. I think if you were to look at, you know, what we said, we said, hey. You know, the number of proof of concepts would pick up in fiscal year 2026. We are seeing that. I think with regard to broader enterprise AI adoption, we've always believed it's use case by use case. It's not a horizontal technology that gets deployed. And so it really depends on the ROI from the use cases. That we see. There, we are seeing, like we said, health care and life science was ahead of the market. You know, some of the other ones, you know, kind of heavy in proof of concept, but not yet in production. Kris Newton: Okay. Thank you. Thank you. Your next question comes from the line of Wamsi Mohan with Bank of America. Please go ahead. Wamsi Mohan: Yes. Thank you so much. George, you said at the end of your prepared remarks that you would be capturing share in the market. And I was wondering how much of that is predicated on some of the flexibility you have in pricing given the supply that you have secured versus product portfolio mix capability? How are you thinking about that? And I have a follow-up. George Kurian: Mean, broadly speaking, once the in a transaction, the majority of the value is in software. And the data platform that the company that the customer is signing on to. Right? They train their teams on the use of the platform. I think our growing differentiation, not only with cloud, but cyber bringing more advanced data management capabilities. This the leading indicator. I think when you are trying to displace the competitor, having a, you know, kind of flexible set of tools both things like Keystone or, you know, subscription type services and the ability price aggressively is helpful. Wamsi Mohan: Okay. Okay. Thanks, George. And just a follow-up. You just raised your public cloud gross margin range and you're already kind of at, you know, more than halfway through that, range with slight increase in revenue in the quarter. I'm just kind of wondering like what's a natural ceiling with for this business? That you see? And maybe you can just maybe, Wissam, can just comment on cash flow as well. A little bit weak in the quarter. Just thinking through sort of trajectory over there, that would be helpful. Thank you. Wissam Jabre: Sure, Wamsi. So let me start with the first part of your question. On the cloud gross margin, look, this is the second quarter we're operating within our upgraded target range. We feel comfortable operating within this range. We've seen the mix in that business shifting a little bit more towards software. And as we talked about before, we've had some roll-off and depreciation. Having said that, there could be potentially an upward bias, but it's too early to talk about that today. I would say, we're still comfortable operating in that within that sort of 80% to 85% range that we published last quarter. Respect to the cash flow, it is there's a bit of seasonality in our cash flow. And so Q2 is typically lower, in some cases, sometimes the lowest point in the year. Also in Q2, we had the last installment of the tax payment, which had to do with the transition tax that was related to the law that was enacted back in 2017, I believe. So those are, I would say, the couple of factors influencing Q2 cash flow. Wamsi Mohan: Okay, great. Thank you so much. Kris Newton: Thanks, Wamsi. Next question comes from the line of Param Singh with Oppenheimer. Please go ahead. Param Singh: Yes. Hi, and thank you for taking my questions. So really wanna dive a little bit more into, you know, your AI wins. You talked a little bit about AI differentiation, the AFX, and what's helping you win versus competitors. Wanted to understand, you know, what are you hearing from customers technically? Do you feel you're there yet? And if you could share, what mix of your AI wins are with existing customers as opposed to taking share from new customers? George Kurian: I think with our, you know, AI win, just like with our all-flash business, we are bringing on a lot of new customers. And then I'm talking about the on-prem business. The cloud business has been a very strong contributor to new clients. As we have shared, roughly half of all our cloud customers are net new to NetApp. Right? And that's pattern has stayed the same for a very, very long period of time. So if you talk about the enterprise storage business, the, you know, number of new customers that are signing on to us has been strong. A lot of that is because of unified data management, you know, hybrid cloud, you know, kind of deployment options. And an increasing number of customers coming because of our built-in Mist two compliant cyber resilience solutions. And so those are the key sources of wins. I think with regard for enterprise AI, we feel really, really strong. Yeah. We are we don't have we are ahead of all the competition. Most of the competitors have, you know, kind of point products. They don't have an integrated stack. They don't have hybrid. They don't have all of those pieces that we have. Do we feel good? You know, clearly, in our installed base, we have an enormous because we hold all the data. And as we talked about at our inside conference, we can bring AI to your data rather than copy all your data over and do AI. Param Singh: Got it. And, before my follow-up, anything sorry. So just a quick follow-up. You know, assuming that, you know, you keep winning and you, you know, your revenue trajectory is gonna improve on the product side with incremental workloads coming into AI inferencing. After that, you have Keystone going faster, easier comps with Spot, increasing public cloud mix, wouldn't it be reasonable to assume that off of 5% you know, normalized go through this year, you should see an acceleration to next year. Would that be the right way to think about it? George Kurian: I'll just say people guide fiscal year 2027 when we guide fiscal year 2027. All of the comments you made are in terms of a growing part of our business is coming from faster-growing, you know, components of our business. Like cloud, Keystone, all flash, and AI. And I think that as that mix gets to be a bigger part of our business, you should expect acceleration. But we'll guide fiscal year 2027 when we get there. Param Singh: Thank you so much. Appreciate it. Wissam Jabre: Yep. Thank you. Kris Newton: Your next question comes from the line of Ari Terjanian with Cleveland Research Company. Please go ahead. Ari Terjanian: First, just on the quarter, good to hear the uptick in large deal activity. I know, George, at the start of the year, you referenced some larger deals in the pipeline. What do you think drove some of the larger deal activity this quarter? Was it execution or maybe there's some pull forward ahead of potential shortages? And then, you know, my second question, you know, it seems like topics was down year over year. It seems like it's been trending that way. How sustainable is that? Is that more timing related of hiring? How should we think about that in the second half? And next year? Thank you. George Kurian: Yeah. I think, first of all, with regard to, you know, Quinn, listen. This is execution. Right? We said we had good pipeline, and we are executing to that. I do not think that there are pull-ins due to supply chain. Right? I mean, listen. We have never said there's a supply chain issue in our, you know, kind of our pipeline. And so I just we'll just say, hey. These are wins. You always get some that get closed earlier than others and some that get closed later. I think that, you know, our strength in the business helped offset a significant, you know, kind of deterioration in U.S. public sector. Due to the shutdown. And so we feel good about that. With regard to OpEx, I'll let Wissam comment on it. Wissam Jabre: Yeah. With regards to OpEx, look, this is a matter of time. We expect it to be potentially slightly higher from here for the second half. We do wanna continue to invest in the business. We wanna invest in the growth of our business. And so, I'll leave it at that. Kris Newton: Thanks, Ari. Your next question comes from the line of Amit Daryanani with Evercore. Please go ahead. Amit Daryanani: Hi. This is Hannah for Amit. Was just wondering for All Flash, the growth accelerated rather well. This quarter. Can you just touch on what drove that? And was it pricing, portfolio refresh? Or was it AI? George Kurian: I think that, from a workload perspective, AI was noticeable. With regard to the mix, listen, I think we have refreshed the full set of systems last year, Anna. And so we're seeing the benefit of that as customers have qualified the systems and started to use it. And then we saw strong results, especially in the high-performance flash area. Where our offerings are, you know, did really well in the quarter. Kris Newton: Thanks, Anna. Your final question comes from the line of Asiya Merchant with Citigroup. Please go ahead. Asiya Merchant: Great. Thank you for taking my question. Just I was wondering, you answered partly that about the high-performance mix shift. I think there was some mix shift that worked the other way in the prior quarter. So just as you look ahead, the guide for the, you know, overall gross margins ticking higher here, you can just kind of lay out how you're thinking about the mix here. And then what's embedded in terms of public cloud revenues? Because obviously that's the higher margin. What's embedded in terms of public cloud revenue growth expectations? For the third quarter? Thank you. Wissam Jabre: Hey, Asiya. Thanks for the question. Look, we don't guide to that level of granularity. I think I've said enough with respect to product gross margin to sort of give an indication as to how we expect the next couple quarters to shape up. With respect to public cloud, I would expect as I said, from a margin perspective, we're comfortable in where we are operating exiting Q2. And from a revenue perspective, we talked about the growth being very much in line with what we've seen over the past, let's say, couple of quarters. So hopefully, this helps. Kris Newton: Alright. Thanks, Asiya. I'm gonna turn it over to George for some final remarks. George Kurian: Thank you, Kris. Strong execution and operational discipline enabled us to deliver a strong second quarter. Our focus on AI, all flash, and public cloud continues to yield top-line growth in an uncertain macro environment. In the quarter, we introduced substantial innovation to extend our differentiation and further solidify our leadership position. Looking ahead, we remain confident that our visionary approach to a data-driven future will enable us to outgrow the market and capture additional share, driving value for customers, partners, and shareholders. Thank you. Have a great Thanksgiving. Operator: Ladies and gentlemen, this concludes today's call. Thank you all for joining. You may now disconnect.
Operator: Greetings, and welcome to the Titan Machinery Inc. third quarter fiscal 2026 Earnings Call. At this time, all participants are in a listen-only mode. A question and answer session will follow the formal presentation. As a reminder, this conference is being recorded. I would now like to turn the conference over to your host, Mr. Jeff Sonnek with ICR. Thank you. You may begin. Jeff Sonnek: Welcome to the Titan Machinery Inc. third quarter fiscal 2026 Earnings Conference Call. On the call today from the company are Bryan J. Knutson, President and Chief Executive Officer, and Bo Larsen, Chief Financial Officer. By now, everyone should have access to the earnings release for the fiscal third quarter ended October 31, 2025, which is also available on Titan Machinery Inc.'s Investor Relations website at ir.titanmachinery.com. In addition, we are providing a supplemental presentation to accompany today's prepared remarks along with the webcast and replay information, which can also be found on Titan Machinery Inc.'s Investor Relations website within the Events and Presentations section. We would like to remind everyone that the prepared remarks contain forward-looking statements and management may make additional forward-looking statements in response to your questions. Statements do not guarantee future performance and therefore undue reliance should not be placed upon them. Forward-looking statements are based on management's current expectations and involve inherent risks and uncertainties, including those identified in the forward-looking statements section of today's earnings release and the company's filings with the SEC, including the Risk Factors section of Titan Machinery Inc.'s most filed annual report on Form 10-K and quarterly reports on Form 10-Q. These risks and uncertainties could cause actual results to differ materially from those projected in any forward-looking statements. Except as may be required by applicable law, Titan Machinery Inc. assumes no obligation to update any forward-looking statements that may be made in today's release or call. Please note that during today's call, we may discuss non-GAAP financial measures, including results on an adjusted basis. We believe these adjusted financial measures can facilitate a more complete analysis and greater transparency into Titan Machinery Inc.'s ongoing financial performance, particularly comparing underlying results from period to period. We have included reconciliations of these non-GAAP financial measures to their most directly comparable GAAP financial measures in today's release and supplemental presentation. At the conclusion of our prepared remarks, we will open the call to take your questions. And with that, I would now like to introduce the company's President and CEO, Bryan J. Knutson. Please go ahead, Bryan. Bryan J. Knutson: Thank you, Jeff. And good morning to everyone on the call. I will start by providing an update on our inventory optimization progress and operational focus areas. And then discuss the current environment across our segments before turning the call over to Bo for his financial review and comments on our fiscal 2026 modeling assumptions. Nine months into the fiscal 2026, we are making meaningful progress on our inventory optimization initiatives which will position us to emerge from this cycle leaner and stronger. Our team did an excellent job executing in what remains a very challenging market environment. As we head into the final quarter of the year, our focus is on finishing strong and continuing to drive inventory optimization while maintaining the customer relationships and service excellence that differentiate us in the market. We have made substantial progress through the first nine months of the fiscal year, reducing total inventory by $98 million. As I just mentioned, I am extremely proud of the disciplined work our teams have been doing all year to move equipment in a very difficult demand environment. And we are confident we will significantly exceed our $100 million full-year reduction target. As such, we are raising our inventory reduction target to $150 million. The quality of our inventory also continues to improve. It is fresher and has an increased mix of more high-demand categories. But we are not stopping there. We still have excess inventory in certain seasonal new equipment categories as well as our overall used equipment level. Our focus remains on finishing this fiscal year in a healthier inventory position, so that we can return to the more normalized equipment margins that we have historically achieved. Regarding equipment margins, they beat expectations for the quarter driven largely by a more favorable sales mix and our improved inventory position. Bo will provide further details but I do expect equipment margins to moderate somewhat in the fourth quarter given less favorable sales mix and additional inventory optimization efforts as we finish the year. The work we are doing now on inventory optimization is about setting ourselves up properly for next year over maximizing near-term margins. Our customer care initiative continues to demonstrate strategic value and remains central to our operating strategy. While equipment demand remains under pressure at this phase of the cycle, our parts and service businesses are generating well over half of our gross profit dollars. The stabilizing force of our parts and service business is essential in times like these. Keeping us closely engaged with our customers allowing us to add value to their operations, and positioning us well for when equipment demand eventually recovers. This relentless focus on our customers optimization, both domestically and abroad, dovetails with our recent activity surrounding footprint. As you may recall, we acquired Heartland Ag Systems in 2022, which allowed us to gain access to the full product line of Case IH application equipment. Including self-propelled sprayers and fertilizer applicators, along with incremental sales opportunities to the commercial ag application segment of the market. As a part of the integration process of that business, we have recently divested certain stores outside of our core footprint and sold them to local CNH dealers in the respective areas. This change will allow us to focus our resources on markets where we can best leverage our broader service network to provide best-in-class service and support to our customers and deliver improved shareholder returns. In that same vein, we have also taken an objective look at our international operations to ensure we are allocating capital to high-performing markets. Our German operations have faced challenges that have historically weighed on returns within our year operating segment. And as such, are in the process of divesting our dealership operations located in Germany, working in close coordination with CNH and local New Holland dealers in the region. An additional part of our footprint optimization is continuing to build upon the dual-brand strategy that we previously implemented in approximately one-third of our US store network over the years. For instance, in Australia, we recently gained access to the New Holland distribution rights in six of our 15 rooftops. While we are not adding new rooftops in the country, we now have both Case IH and New Holland brands available in these markets, helping us provide better scale and customer service through improved coverage. To drive increased market share while capturing synergies from both brands. We remain focused on organic growth through market share gains and focusing on our customer care strategy to drive higher parts and service revenues. At the same time, we are well-positioned to continue to pursue M&A opportunities that align within our strategy that focuses on leveraging our service network to provide best-in-class customer service while driving scale and efficiencies to achieve higher levels of profitability. With that, I will now turn to our segments. In domestic ag, the quarter performed within our expected range. Despite an environment that remains challenging for our farmer customers. While the harvest season is now largely complete, and yields were generally solid across our footprint, farmers continued to face multiple headwinds. These include depressed commodity prices, which is the fundamental issue pressuring farm profitability, as well as the government shutdown, which slowed payments to farmers adding to current cash flow challenges, along with higher interest expense. While we have seen some improvement in commodity prices recently, they generally remain below breakeven levels for our customers. And while it is encouraging to see China committing to resume soybean purchases, it is unlikely that this will result in a sustainable inflection in commodity prices in the near term. Further, while the reinstatement of 100% bonus depreciation is a positive for those customers who find themselves in a taxable position, many simply do not have the income to take advantage of it this year. The bottom line is that without a significant improvement in commodity prices, or substantial additional government support, equipment demand is likely to remain at trough-type levels for the near term. Now turning to our construction segment, which continues to face some softness reflecting the broader economic uncertainty. Equipment margins remain subdued, pressured by some of the same variables that are impacting our domestic ag segment. Infrastructure and data center projects are providing a baseline level of activity, while the overall demand environment remains somewhat softer than the highs of recent years. But still at healthy levels. Europe had a strong third quarter, as Romania continued to drive segment performance as customers capitalized on EU subvention funds up to the September deadline. However, absent this temporary stimulus, the underlying demand in the region remains soft and is tied to the broader ag cycle. Australia continues to experience a similar backdrop as their domestic ag business with industry volumes below prior trough levels. However, the third quarter also reflected some difficult comparables relative to the prior year. The market remains challenging, but the fourth quarter revenue should be closer to what we saw in the prior year. In closing, we have accomplished a great deal over the past year reducing total inventory by over $500 million from peak levels in Q2 of the prior year. This has been a full team effort, and why I want to express my appreciation for how our people have maintained exceptional customer service while executing these initiatives by outperforming the market. The agricultural equipment market remains challenging and the industry is not expecting a near-term recovery. However, we are staying disciplined in our execution managing what we can control, and positioning the business to perform well when market conditions eventually improve. With that, I will turn the call over to Bo for his financial review. Bo Larsen: Thanks, Bryan, and good morning, everyone. Starting with our consolidated results for the fiscal 2026 third quarter. Total revenue was $644.5 million compared to $679.8 million in the prior year period. Reflecting a 4.8% decrease in same-store sales driven by weaker demand in our domestic ag, construction, and Australia segments, largely offset by stimulus-driven strength in our European segment as Bryan discussed earlier. Despite the sales headwind in the third quarter, gross profit was essentially flat at $111 million compared to $110.5 million in the prior year period. While gross profit margin expanded to 17.2% as compared to 16.3% in the prior year. This was largely driven by a 70 basis point improvement in our equipment margins for the third quarter versus the prior year comparative period. Notably, equipment margins for our domestic ag segment were 7% in this year's third quarter. Which is a significant improvement from the 3.1% that was achieved in the first half of this fiscal year. This improvement is largely driven by our improved inventory position and a favorable sales mix. But also benefited from a $3.7 million accrual for manufacturer incentive plans for which nothing was accrued in the first half of the year. Operating expenses were $100.5 million for 2026. Compared to $98.8 million in the prior year period. Our headcount and discretionary spending is down year over year as a result of disciplined expense management. However, the small increase in total operating expense was led by higher variable compensation and some transaction-related expenses. Lower plan and other interest expense was $10.9 million as compared to $14.3 million in the prior year period reflecting our continued efforts to reduce interest-bearing inventory over the past year. In 2026, net income was $1.2 million with earnings per diluted share of $0.05 compared to net income of $1.7 million or earnings per diluted share of $0.07 for the same period last year. Now turning to a brief overview of our segment results for the third quarter. Our domestic ag segment realized a same-store sales decrease of 12.3% which took segment revenue to $420.9 million. Segment pretax income was $6.1 million compared to pretax income of $1.8 million in the third quarter of the prior year. Reflecting the positive equipment margin dynamics that I discussed earlier, as well as lower operating expenses, and lower floorplan interest expense as compared to the prior year. In our Construction segment, same-store sales decreased 10.1% to $76.7 million which was driven by lower equipment sales. Pretax loss was $1.7 million compared to a pretax loss of $0.9 million in the third quarter of the prior year. In our Europe segment, same-store sales increased 88% to $117 million which includes a $6.1 million positive foreign currency impact. Net of the effect of these foreign currency fluctuations, revenue increased 78%. Which was primarily driven by Romania as customers capitalized on EU subvention funds ahead of the September deadline. Pretax income for the segment increased to $3.5 million compared to a pretax loss of $1.2 million in the third quarter of last year. In our Australia segment, same-store sales decreased 40% to $29.9 million which included a 1.3% negative foreign currency impact. Net of the effect of these foreign currency fluctuations, revenue decreased 39%. This decrease reflects the continued normalization of sprayer deliveries in fiscal 2026 after having caught up on a multiyear backlog of deliveries during fiscal 2025. Pretax loss was $3.8 million compared to a pretax loss of $0.3 million in the third quarter of last year. Now on to our balance sheet and inventory position. We had cash of $49 million and an adjusted debt to tangible net worth ratio of 1.7 times as of October 31, 2025. Which is well below our bank covenant of 3.5 times. Regarding inventory, as Bryan mentioned, we reduced our total inventory by $98 million through the first nine months of the year to $1 billion. Of that $98 million reduction, approximately $15 million came from equipment sold through three domestic divestitures we completed. The vast majority of the reduction reflects the disciplined work our team has been doing to move equipment in a challenging demand environment. Our cumulative total inventory reduction from peak levels in Q2 of the prior year now stands at $517 million. Beyond the headline inventory reduction number, we are also seeing a meaningful improvement in the quality of our inventory. We continue to focus on reducing aged inventory. Which we define as equipment that has been on our lots for more than twelve months. Aged equipment inventory peaked in May fiscal year and we have been able to reduce this by a total of $94 million over the last five months. This aged inventory reduction is critical to returning more normalized equipment margin levels. Given the progress we have made and the programs we have in place to continue to drive sales in the fourth quarter, we have confidence in making further progress on aged inventory and inventory levels overall. As such, as Bryan mentioned previously, we are increasing our inventory reduction target to $150 million for the full fiscal year. Turning to our fiscal 2026 modeling assumptions. We are refining our revenue expectations for both the Construction and Europe segments based on our year-to-date performance. While keeping our assumptions for domestic ag and Australia intact. We are now expecting construction to be down 5% to 10% compared to our prior expectation of down 3% to 8%. And Europe is expected to be up 35% to 40%, an improvement from our prior range of up 30% to 40%. Reflecting the strong performance in Romania during the third quarter. From an equipment margin perspective, I want to provide some additional context for the fourth quarter. As Bryan mentioned, our third quarter consolidated equipment margins of 8.1% benefited from our improved inventory position and favorable sales mix. Given a less favorable sales mix, and additional inventory optimization efforts in the fourth quarter, we anticipate consolidated equipment margins to moderate back to approximately 7% for the fourth quarter. This reflects three primary factors. First, the fourth quarter is traditionally a big quarter of delivery of multiunit deals for larger ticket cash crop equipment and generally speaking, those tend to have moderately lower margins than other transactions. Second, we continue to work through aged inventory as part of our optimization effort. And third, we anticipate some moderation in Europe following the September expiration of subvention fund availability in Romania. Consistent with our prior expectations, operating expenses are expected to decrease year over year on an absolute basis. And I continue to expect them to be approximately 16% of sales for the full fiscal year. Forward plan and other interest expense is expected to continue to decline as we make additional progress on inventory reduction and mix optimization and we should see some of those benefits in the fourth quarter given the reduction in aged inventory we have seen in recent months. As a preface to our earnings per share expectations, I want to call out the anticipated recognition of a non-cash valuation allowance that is expected to be recognized in the fourth quarter and result in an increase in our reported tax expense by approximately $0.35 to $0.45 per share. Reflecting a variable that was not considered in our previous assumptions. This is dictated by accounting guidance and is influenced by the degree to which our profitability is being impacted by the broader cycle. It is something that we had to recognize in the prior downturn as well, and then subsequently reversed as the industry recovered from the prior trough. I expect a subsequent reversal at some point in the future this time as well. However, this will result in an increase to tax expense for the time being. Based on guidance from regulators, we do not plan to adjust this incremental tax expense out of our presentation of full-year adjusted earnings per share. So I mention it here so you can better appreciate the magnitude that the underlying equipment margin improvement is having on our results in the second half of the fiscal year. To be clear, our margin improvement is being negated by the valuation allowance and as a result, we are reaffirming our adjusted diluted loss per share guidance a range of a loss of $1.50 to $2. In summary, we are pleased with the progress we have made in a challenging demand environment, with industry volumes below prior trough levels. And we are poised to make further progress in the fourth quarter. Our team's hard work advancing our inventory reduction and footprint optimization initiatives are positioning the business for improved financial performance as we move into fiscal 2027. This concludes our prepared comments. Operator, we are now ready for the question and answer session of our call. Operator: Thank you. If you would like to ask a question, please press 1 on your telephone keypad. A confirmation tone will indicate your line is in the question queue. You may press 2 if you would like to remove your question from the queue. For participants using speaker equipment, it may be necessary to pick up your handset before pressing the star key. To allow for as many questions as possible, and one follow-up. Thank you. We ask that you each keep to one question. Our first question comes from the line of Liam Burke with B. Riley Securities. Please proceed with your question. Liam Burke: Thank you. Good morning, Bryan. Good morning, Bo. Morning. Morning. We saw very nice results on parts and service, excuse me, service was down 4%. Is that just normal quarter-to-quarter seasonality, or is there something within that number on that down year-over-year number that is influencing it? Bo Larsen: Yeah. So there is some noise there from a quarter-to-quarter perspective. The way service is reflected does get impacted by how much new equipment we are delivering and how much of their labor is going towards PDI, which ultimately shows up as whole good versus service revenue. Overall and big picture, service generally speaking is flattish this year in a world where large ag new equipment is down about 30%. Pretty happy with that. Certainly driving initiatives and expecting over the long term, as we have talked about for a while now to be able to drive sustainable growth. But, again, stability in this environment, will take for now as we work on some underlying things such as driving higher take rates on extended warranties, preventative maintenance agreements, and the like. To really help us accomplish what we want and that is to see something more like mid-single-digit growth on average over a longer period of time. Still feeling good about all that. Liam Burke: Great. And then on the construction, same-store sales just do not seem to be recovering. More in line with ag. We would think that there would be less decline, but it seems to be either the same or no getting worse. When most of the larger infrastructure players and larger construction players are doing okay. Bo Larsen: Yeah. The first thing I would say, and I am sure Bryan will add to it as well. Underneath that for us, I would say that there are some specific factors that are not necessarily reflective of the market. Specifically, last year was a big year for us recovering and catching up on the delivery of wheel loaders. That extends back to the production or COVID production supply chain constraints. So last year, we received a lot in, we delivered a lot of them. Q3 was a big quarter for that specifically. So that was less about the market conditions and more about catching up on that backlog. You know, underneath that, we do see more stability ourselves and kind of reflective of what the overall market environment is like. I do not know if you wanted to add anything. Bryan J. Knutson: Yeah. Just as it relates maybe to the overall infrastructure impact we certainly do not play as much in that market as, say, Caterpillar would, but, you know, a good a better portion of our business is tied to ag in general. With, as Bo mentioned, wheel loaders and a lot of material handling equipment. As well as Razwitch with the interest rates where they are know, has still been lagging. But we are certainly seeing some good stability and data center projects up up here in the Midwest. And, again, it is basically hanging in there, mainly what you are seeing in the comparables is what Bo mentioned with just the year-over-year comparison to the change in the wheel loader backlog shipment that we had. But we are expecting, you know, potentially here rate cut in December, which could be positive news and a lot of our contractors are you know, I will say, cautiously optimistic here as they start to look to at their 2026 schedules. And so yeah, we are looking at potential uplift for next year in that market. Liam Burke: Great. Thank you, Bryan. Thank you, Bo. Bryan J. Knutson: Yep. Thank you. Operator: Our next question comes from the line of Mig Dobre with Baird. Please proceed with your question. Mig Dobre: Good morning, and congratulations on really good progress your team seems to be making here. So I guess my first question, I would like to talk a little bit about Europe. And appreciate the guidance raised here, but if I heard you correctly, the tailwind in Romania from those subsidies is going to dissipate, went away in September. What are you seeing in that region more broadly? Is and I guess, really, the answer to my question is at this point, all of us really kinda focus on fiscal 2027, you know, the current fiscal year is pretty much done. What is the right way to think about this portion of the business for fiscal 2027, recognizing that the comparisons here are really difficult. Bo Larsen: Yeah. No. I appreciate the question. And for sure, Romania, you know, this year, essentially doubled up year over year. And kudos to the team for on that and capitalizing on all the opportunity that was there. You know, first of all, just in terms of what we are seeing in the region, both for Romania and Bulgaria, I would say they have not had the best weather conditions in both calendar 2024 and 2025. So whereas more broadly in Europe, some of the yields were better. They were not as well off there. So that is a bit of a headwind. Obviously, the funds kinda helped us mask some of that and overperform there. From a next year backdrop perspective, I would say and, again, this is directionally speaking, we will provide guidance when we get on our March call. But for Romania, the pullback, you know, 30% to 40% we will sharpen our pencil on that, but that is not out of the range of reasonable given the backdrop that they have and the significant growth they had this year. For Bulgaria and Ukraine, I would say more stable and opportunity for growth. So ex Germany, of course, which we are talking about divesting of, mix all that in, you are talking about something, again, directionally speaking, we will sharpen the pencil, some high teens, maybe 20% down year over year forge are up or for Europe ex Germany. Mig Dobre: That is really helpful. And, you know, you guys are not hearing of any other stimulus packages or anything of the sort that might be might be going on in region outside of Romania? And we can you know, Ukraine as well. Obviously, those guys have been put a lot. Bo Larsen: So it does actually continue a bit. And, again, we will continue to sharpen our pencil. But there are still funds in play even in Romania through 2027 for certain categories of equipment. They are pretty prescriptive. We feel like we are in a decent position to continue to take or to execute on those opportunities. We will continue to sharpen our pencil, provide more clarity. But again, I would say, you know, an amazing job by the team to double up the business year over year. Some pullback expected. We will continue to sharpen. Funds are there. Maybe not as significant as we saw this year. Mig Dobre: Sure. Reverting back to The US business, it sounds like you guys are doing some more on the footprint which, you know, you have done in prior downturns. As well. I guess the commentary, as I heard it from Bryan in the prepared remarks, was pretty subdued as we think about fiscal 2027. And, again, directionally, I am sort of wondering a couple of things here. Should we plan for another year of decline in fiscal 2027 on what you know today about your North American business? And if that is the case, what is the right way to think about margins As you have reduced the inventory, are we to the point where we can see on the equipment side, more normalized margins even if we have to deal with another year of top line or volume And then I will have one final follow-up. Bo Larsen: Yep. From a margin perspective, and then I will turn it over to Bryan to talk more about just about footprint in general there. So, yeah, back half of the year, obviously, you saw a pretty significant So I am talking domestic ag here, setting aside the other stake. Segments, which have not had as much volatility. First half of the year, equipment margins were about 3.1%. Back half of the year, equipment margins about 6.5%. If you set aside manufacturer incentives, we are generally accruing and recognizing in the back half of the year as we gain certainty, But back half of the year margins would be more like 5.25 So if we go into next year and there is an assumption that, you know, industry volume is down again and kind of setting a new historical low at least for the past couple of decades, that five and a quarter is maybe a decent proxy to start with for the first half of next year. And then continue to see us driving improvement from there. I do not know if you wanted to add any on the industry in general. Yeah. Make out maybe just add a little bit on footprint and then and then secondly on the industry industry next year. So with footprint, we work very hand in hand with CNH They do not get surprised by any acquisition we do, nor do they with any divestiture that we do. And so we have done a lot of work in recent years here on our strategic plan and we are just really continuing to work that plan. So if you look at, some of the larger acquisitions that we have done and as we refine those now such as some of the divestitures we have done related to our Heartland application business, We will continue to refine that. And, again, we are working hand in hand with CNH in our fellow CNH dealers on that. And we believe that is a great solution for our customers in the end. And we are very pleased with that acquisition, and, again, as we continue to refine it. Secondly is, you know, just continuing to get ready for additional acquisitions that are will be accretive and in line with our strategic plan. And so we will continue to refine our footprint and optimize in the areas where we perform the best. And can really maximize our customer care strategy And then third, you will see us doing a lot with the multi-brand strategy with CNH as you saw. We just added the contract at five or six of our rooftops in Australia where we did not actually add any rooftops, but we added the new Holland contract to six of our 15. As well as we have got a third of our North American footprint that is dual branded. And, there is a lot of value there that we can unlock for our shareholders and for our customers and give better customer services. We do that we are going to continue to execute on that strategy as well. And just with the overall demand, Meg, I mean, I think as you know, there are a lot of variables in play here. We and we will see what continues to happen with soybean sales and soybean consumption. So really on the demand side and as we continue to look at stock to use ratios here, Also with, Ren Fuel standards as we get into January here, think we will see some further development on that. Things around E15 and biodiesel especially. And then really, if you look at the government stimulus, it is going to be big wild card here. So with the shutdown, you know, no assistance came. We will see what comes yet in 2025. Of course, we are running out of time in the calendar year. So 2026, I think that is going to be the big question as at today's commodity prices, even though we have had a recent uptick, many of the farmers are still not at profitable levels here even with the good yields that we had. So, that is going to, I believe, be another big wild card for next year here that we should, get a lot more color on here as especially the February WASDE report comes out and as insurance rates get locked in at the February and so forth. Mig Dobre: Alright. And then my last question. From an inventory standpoint, maybe you can comment a little bit as to how you think about that I and I know I have asked this question before that you record dollar inventories. Right? But I we gotta sort of keep in mind that the price of the equipment that you have in inventory has gone up a lot over the years and, you know, your store count has increased as well. Is there a way to maybe help us understand or maybe frame for us where you are in terms of unit count of inventories and you know, maybe relative to the prior cycle or really any way that you think shareholders might find it helpful? Thank you. Bo Larsen: Yeah. And to start with, certainly, inventory being a big topic, trying to think about, you know, the best ways to provide transparency without overcomplicating things there. And so certainly super impactful to talk about the price increase You know, over the last year, we had talked about the cost of a four drive going up more than 80% since 2014. We have talked directionally speaking again in the last year. As we Versus where we started the last downturn, had about one third as many used combines which is, you know, an indicator an important indicator in terms of how much work there is to be done on the used equipment side of things. So we will keep working on, you know, the best ways to portray that info. But I mean, it is pretty easy to quickly just think about it in terms of like half the number of units. And, yeah, we are much better positioned than we previously were. And that is really shown in just what happened with our equipment margins in Q3, for example, versus the first half of the year. Our stance has been to aggressively manage our inventory, including the value in which sits on our balance sheet, that is pulled forward some of that. P and l pain, and that is where we saw lower margins than we had seen historically. But then you saw that significant inflection here in the third quarter. We feel really good about where things are priced the number of units we still have to move and exactly what we need to continue to accomplish this year to set ourselves up for success next year. We feel really good about where we are going to be to end the year. And then in a, you know, a market where North America is potentially down a bit again from there, it is going to be a continued focus on managing that aging profile but we are just going to be in a lot better position, to execute at the market instead of trying to be more aggressive out there. And so we should continue to see progress on those equipment margins and, of course, on that reduction in floor plan interest. Bryan J. Knutson: Yeah. Ming, I would just add, you know, good good point on your part, As you said, as we have had equipment prices, per unit in some categories nearly double in less than ten years here, Dollars is not in and of itself, a good way to look at it purely. And as you mentioned, also increasing our store count as well. So as you know, inventory turns is a really good way to look at that. And also interest expense in general. So you know, those are some of the key things in for us is just as we go forward to manage our interest, expense mitigate that as much as possible. Maximize our manufacturer floor plan terms, etcetera. And ultimately, presale with customers So the high dollar cash crop, high ticket equipment, is presold and not sitting on our balance sheet for any longer than possible and especially accruing interest expense. So you know, we will continue to monitor, turns and entered expense are a couple of big indicators there. Mig Dobre: Alright. Very helpful. Thank you, guys. Bryan J. Knutson: Thank you, Mig. Operator: Thank you. Our next question comes from the line of Ted Jackson with Northland Securities. Please proceed with your question. Ted Jackson: Thanks. Good morning. Bryan J. Knutson: Good morning. Good morning, Ted. Ted Jackson: So I wanted to start out and just kinda ask a few questions around inventory. Just to make sure, you know, I kinda understand everything and it will drive a few other things. So you commented. So your inventory year to date is down $98 million. But it would be down $75 million. You had not done the divestitures. Is that correct? Bo Larsen: Yeah. That is correct. Ted Jackson: Okay. So when I think about the and that is fabulous progress, by the way, so I wanted to make sure to say that. But when I think about the $150 guidance that has been put out, if you had not done any divestitures, what would that guidance be? Bo Larsen: Well, and there is a couple of through the end of the year. Right? Essentially, what I am saying is Australia acquisition that we did largely offset those divestitures. Then the other wrinkle, I guess, we have is the Germany divestiture. That will be helpful there as well. But yeah. I mean, somewhere in the $130, $140 range. But, again, there are some offsetting impacts. The other thing that was against us from a dollars perspective was just the FX. On the Europe side, which added to inventory without actually adding units. And last last thing I would say just to gauge the progress, and again, this is dollars, so it is not exactly units. But in the last down cycle, it took us two years to decrease inventory $348 million. It took us three years to decrease inventory, $543 million. You know, we are going to go past that in an eighteen-month period of time here. Again, it just speaks to the approach that we are taking into managing this down faster. To get position heading into the next year. Ted Jackson: So putting it into, like, context of, you know, when we were talking about inventories before and units and everything, the, the $150 to a $100 on a unit basis, you know I mean? Even if, like, if you will make it look organically, you are taking up your view of terms of what you are going to be able to take your inventory numbers down. Let us call it on a unit basis. You know, at you know, regardless of the divestitures that, you know, you are you know, it is a it is indeed a a a change. You see what I am saying? It is not it is not being driven by a change in your footprint. It is being driven by accomplish. change in your view with regards to what you are going to be able to. Bo Larsen: Oh, yeah. Absolutely. And, I mean, the biggest thing that has been reduced here to make sure that you are appreciating it is aged used equipment, which is you know, the biggest risk in turn of valuation. So just I mean, could not be happier with the progress the team has made. It about the additional progress we are going to be able to make. It reflects on the balance sheet in a given quarter. The reality is this is something that we have been at for more than two years now as we have seen how things have been evolving with lead times when we are getting stuff in from the OEMs, how we are digesting that. So really great progress, we look to make more here in the next couple of months. Ted Jackson: And then with regards to the change with with your outlook for inventory. Is it by chance being done because you have a is there is is there a is that change more pessimistic view of how you know, both this goal '26 looks to be Or you you understand what I am saying? I mean, is it you know, like, you know, if your view is that, you know, the the market going forward is weaker than I expected so I do not need as much inventory. So I am going to get try to get rid of more inventory. Do struggle with that? Is it a change in terms of know, how you kind of view the macro, or do you still kinda feel like we will move on? I mean, you often you know, been let us call it calendar '25, and we should have a more stable market in '26. And the that that that view that has been, you know, generally expressed across the ag market, the ag ag players for the last, you know, several quarters is still intact. Does that make sense for me? Yeah. Big picture wise, I do not think that things have. Bo Larsen: shifted drastically. I mean, the and the OEMs in the general space have been talking about North America potentially down somewhat next year. But not so much that it changes, you know, our trajectory of where we want to go. It is more a reflection of the work that we still feel like we, have and and can accomplish for the year. I would say, though, that as we flip the calendar into next year, so we are going to get to a pretty pretty darn good spot ending this year, all things considered. We do absolutely expect some seasonal build in the spring. Kinda refreshing some categories ahead of the selling season. So I would not expect further reduction in the back half of next year. But getting to a good spot at the end of this year, seasonal build in the first half of year. And then depending on where we see the market shaping up, probably, you know, taking it back down a bit in the direction of kinda where we ended this year. That that is kind of my base case scenario that I would lay out for you. Yeah. And, Ted, I would just add, you if we go back to. Bryan J. Knutson: the earlier discussion with Mig there around you know, we for our growers next year, we unless we see a significant uptick here in commodity prices or, again, the wildcard with government assistance. Next year, looks like it could be challenging again for our growers, so we want to be you know, prudent about how we are stocking our inventory accordingly. And then also as we talked about interest expense, you know, with interest rates, as high as they are, it is important that we are mitigating the interest expense. And then the third thing I would say for next year and going forward is just again, a strategic change for us. And in our balance sheet management. And really, as we talk about our footprint optimization, one of the benefits of that is we to refine and get our tighter contiguous footprint, which allows us to leverage that footprint and leverage our scale and share inventory more freely amongst our stores and still be able to you know, capture every sale. That is still the ultimate goal. And keep our customers up and running and satisfy their equipment needs and make them more efficient. So to never miss a sale, but to do that with leaner inventories. And so that is where we are headed. Ted Jackson: Okay. And then my last question, it is maybe more of just, like, actually for a little color. So, you know, I mean, a big thing with CNH is they really want to get, their their, their brands consolidated into, you know, under one roof. And you made a comment that in Australia, six of your 15 roofs now take both, you know, case and New Holland equipment. I was kinda curious when if you could provide a similar kind of metric for the other regions and maybe talk about you know, well, maybe it is too much. But, you know, area you know, like, many when you think about that, is there first of all, how much of your footprint at a region is you know, is that consolidation already taken place? And I do not know. Maybe to the extent that you can, how you think you are positioned for further consolidation of rooftops for CNH because it is such an important longer-term strategy for them. That is my last question. Yes. Bryan J. Knutson: Thank you. It is for sure. And so we are very much aligned with with CNA in our our fellow dealers in that strategy. And we think there is a lot of value for our our customers and our shareholders again there. And we can it gives us additional scale. It gives our customers most importantly, a lot of benefits as we do that and allowing us to give them quicker response times and less downtime ultimately. So we are very focused on that. We have been for a long time, We like that that we have seen that growing, you know, additional energy around that. Strategy, again, from other dealers and from CNH collectively, And we are going to continue to push on that. You asked how we are sitting now. So that is that six of 15 obviously brings us to just over a third in Australia. And we are going to keep pushing there. We are just about a third in The US, and, we will keep doing the same there. And then in Europe, again, you are seeing that in kind of the earlier stages. So working hand in hand with CNH, in Germany, in that case, we ended up selling, and we will look to again, in other areas be a buyer as continue to move around here, and we leverage that strategy. So that is also part of, again, our strategic strategic plan as we get some dry powder ready here and look to continue to execute on that strategy in coming years. Ted Jackson: Okay. Hey. Thank you very much for taking my questions. Bryan J. Knutson: Thanks, Ted. Operator: Thank you. Our next question comes from the line of Steve Dyer with Craig Hallum Capital Group. Matthew Joseph Raab: Hey. Thanks. This is Matthew Joseph Raab on for Steve. Just want to go back to the government payments. Are you starting to see flow through to your farmers in the footprint, or is it just too early to tell? And then I guess with that, was there any impact in the quarter or on order books given those payments? Bryan J. Knutson: So earlier in the year, they received some and then they received a little bit more in, early summer. And then as we speak, they are receiving a little bit more, which is the final 15%. They receive the 85% of some of the first assistance back in approximately June. And now they are receiving the last of that. However, you know, there was up to nearly $10 billion discussed for soybean assistance. We have not seen that yet. You know, there is a verbal agreement with China to that would potentially return them to about 25 million metric tons annually, which is about what they have historically produced, that is about in line with their five-year average. So you know, we will see if, if it looks like they are going to execute on those purchases, then maybe we see, prices come up and those funds do not need to come through. And vice versa. So I think the government will continue to monitor that. Again, as we look at what is left here for 2025, not optimistic about a lot more getting into our growers' hands other than what is already in motion. But certainly for 2026, I think there is a lot to look at there, when you look at the pricing levels of where they are at today, especially with the current price of wheat and corn and soybeans as an example. But really, generally, most of the commodities are pressured right now. And, again, it does come back to that supply and demand ratios. Matthew Joseph Raab: Understood. Thank you. And then, on the footprint optimization, and then really thinking about Germany, Maybe, Bo, any sense you can give us in the overall contribution Germany was to the Europe segment from the top and bottom line? Standpoint? And then I guess with that any is that enough to move the needle as we think about next year? And what that could mean from a sales perspective? Bo Larsen: Yeah. So overall, for Germany, over the last several years, they have averaged roughly $40 million low forties million top line. And pretax loss of somewhere in the, you know, $4 to $6 million range. So beneficial to transition that off from a bottom line perspective. In the context of our total whole goods revenues you know, not a not a massive impact there. Matthew Joseph Raab: That is great. Thank you very much. Operator: Thank you. That concludes our question and answer session. I will turn the floor back to management for any final comments. Bryan J. Knutson: Well, thank you, everybody, for your time this morning, and we look forward to updating you on our next call. Operator: Thank you. This concludes today's conference. You may disconnect your lines at this time. Thank you for your participation.