Universal Corporation’s (UVV) Management on Q1 2021 Results – Earnings Call Transcript


Universal Corporation (NYSE:UVV) Q1 2021 Earnings Conference Call August 5, 2020 5:00 PM ET

Company Participants

Candace Formacek – Vice President and Treasurer

Conference Call Participants

Operator

Ladies and gentlemen, thank you for standing by, and welcome to Universal Corporation First Quarter Fiscal Year 2021 Earnings Call. [Operator Instructions] Please be advised that today’s conference is being recorded. I would now like to hand the call over to your speaker today, Ms. Candace Formacek, Vice President and Treasurer. Please go ahead.

Candace Formacek

Thank you, Grace, and thank you all for joining us. George Freeman, our Chairman, President and CEO; Airton Hentschke, our Chief Operating Officer; and Johan Kroner, our Chief Financial Officer, are here with me today and will join me in answering questions after these brief remarks.

This call is being webcast live and will be available on our website and on telephone taped replay. It will remain on our website through November 5, 2020. Other than the replay, we have not authorized and disclaim responsibility for any recording, replay or distribution of any transcription of this call. This call is copyrighted and may not be used without our permission.

Before I begin to discuss our results, I caution you that we will be making forward-looking statements that are based on our current knowledge and some assumptions about the future and are representative as of today only. Actual results could differ materially from projected or estimated results, and we assume no obligation to update any forward-looking statements. This is a particular note during the current ongoing COVID-19 pandemic when the length and severity of the crisis and resultant economic and business impacts are so difficult to predict. For information on some of the factors that can affect our estimates, I urge you to read our 10-K for the year ended March 31, 2020, and the Form 10-Q for the most recently ended fiscal quarter. Such risks and uncertainties include, but are not limited to, the ongoing COVID-19 pandemic, customer-mandated timing of shipments, weather conditions, political and economic environment, government regulation and taxation, changes in exchange rates and interest rates, industry consolidation and evolution and changes in market structure or sources.

Finally, some of the information I have for you today is based on unaudited allocations and is subject to reclassification. In an effort to provide useful information to investors, our comments today may include non-GAAP financial measures. For details on these measures, including reconciliations to the most comparable GAAP measures, please refer to our current earnings press release.

Our fiscal year 2021 is off to a slow but respectable start as nearly all of our origins continue to make good progress in moving through their various tobacco growing and processing activities. The first fiscal quarter is generally the weakest of our fiscal year given seasonal timing. This fiscal year, as a result of the COVID-19 pandemic, or COVID, we are also experiencing later openings of the tobacco buying seasons and slower processing due to social distancing and other local government safety requirements. We’ve also had some slower receipts of customer shipping instructions and orders. However, to date, we have not seen a material impact to our supply chain or seasonal planting or harvesting requirements.

Despite COVID-related slowdowns, tobacco volumes in the first quarter of fiscal year 2021 exceeded those of the first quarter of fiscal year 2020. Volumes shipped out of Brazil in the quarter ended June 30, 2020, included inventory that had been uncommitted at March 31, 2020, reducing our overall uncommitted inventory levels. As of June 30, 2020, our uncommitted inventory levels had declined significantly from fiscal year-end 2020 levels and at 20.5% are now just outside our target range. A large portion of the shipped Brazilian volume, however, was lower-margin carryover crop, which impacted results for the quarter.

Results for the quarter ended June 30, 2020, were also impacted by several nonrecurring items, including an adjustment to a contingent consideration for the acquisition of FruitSmart, interest expense associated with the disputed foreign tax matter and an income tax benefit from issuance of final tax regulations for dividends paid by foreign subsidiaries.

Turning to the details. Reported net income was $7.3 million or $0.29 per diluted share for the first quarter of fiscal year 2021, which ended on June 30, 2020. Those results were up $5.2 million compared with net income of $2.1 million or $0.08 per diluted share for the first quarter of fiscal year 2020. Excluding certain nonrecurring items detailed in Other Items in today’s earnings release, net income and diluted earnings per share declined by $4.3 million and $0.17, respectively, for the quarter ended June 30, 2020, compared to the prior fiscal year.

Operating income of $8.5 million for the quarter ended June 30, 2020 increased by $1 million, compared to operating income of $7.5 million for the quarter ended June 30, 2019. Revenues $315.8 million for the quarter ended June 30, 2020, increased by $18.9 million or 6% on higher total sales volumes, offset in part by lower sales and leaf prices as well as a less favorable mix. In the regions, the other regions segment operating loss of $4.3 million for the quarter ended June 30, 2020 was $0.5 million greater than prior year’s first quarter operating loss of $3.8 million. Although volumes in Brazil increased in the first quarter of fiscal year 2021 compared to the prior year, a large portion of the sales consisted of previously uncommitted inventories of lower-margin carryover crop tobacco.

In addition, some volumes in Brazil that were expected to be shipped in the quarter were delayed on limited vessel availability at the port due to COVID pandemic. For the first quarter of fiscal year 2021, compared to the same quarter in the prior fiscal year, lower results in Brazil were partially offset by increases in Asia, largely due to higher volumes in the Philippines and higher volumes in Africa on carryover crop shipments delayed into the first quarter of fiscal 2021.

Operating income for the North America segment for the quarter ended June 30, 2020 of $1 million was flat compared to the first quarter of the prior fiscal year as higher carryover volumes from the United States and lower expenses in Mexico due to timing offset lower processing volumes in Guatemala, partly due to delays resulting from COVID restrictions. The other tobacco operations segment operating income of $7.6 million for the quarter ended June 30, 2020 declined compared to operating income of $10.5 million for this segment in the same period last year.

Results from our dark tobacco operations were lower on reduced volumes in part due to delays from COVID and lower costs in the prior year. In the first quarter of fiscal year 2021, results for the Oriental joint venture were flat, while operating income for the segment benefited from the acquisition in January 2020 at FruitSmart, our new fruit and vegetable processing business compared to the same quarter of last year.

And other items, the interest expense for the quarter ended June 30, 2020 increased by $2.8 million to $6.8 million compared with the same quarter in the prior year, largely on a non-recurring interest expense item associated with an uncertain tax matter at a foreign subsidiary. Selling, general and administrative costs for the first quarter of fiscal year 2021 decreased by $1.7 million compared to the same period in the prior year, as benefits from positive net foreign currency remeasurement and exchange variances, primarily in Indonesia and lower travel costs were offset, in part, by selling, general and administrative costs for the FruitSmart business acquired in the fourth quarter of fiscal year 2020.

Looking forward, we have seen some reductions in projected global crop sizes for both burley and flue-cured tobaccos for crop year 2020. We believe that these reflect a positive adjustment to market conditions and that Burley tobacco remains in a balanced supply position and that flue-cured tobacco is now in a slight oversupply position. We are also continuing to see very strong demand for natural wrapper tobaccos.

We are prudently monitoring COVID developments around the world and are projecting that our sales volumes for fiscal year 2021 will be weighted to the back half of the fiscal year, in part, due to COVID related processing slowdowns and later customer mandated shipment timing. We also have experienced some increased volatility in foreign currency rates, which we believe is related to the uncertainties from COVID.

We are proud of the success we continue to achieve while operating safely in more than 30 countries around the world, during a time of unprecedented and disparate challenges. We believe our commitment to strong local management is our key – in our key operating areas has enabled us to react quickly and effectively to these new conditions. Our business is also built on relationships. Having these strong relationships with our customers and suppliers has allowed us to make the new remote interactions work well.

We’re thankful for the hard work of our employees and the continued support of our customers, growers, and other partners, during these challenging times. As we move forward in fiscal year 2021, we are focused on keeping our employees safe and running our business efficiently, while positioning both our tobacco and non-tobacco businesses for future success. As part of our capital allocation strategy, we have made and will continue to explore disciplined investments in both tobacco opportunities, and non-tobacco businesses that we believe will be able to deliver shareholder value.

At this time, we are available to take your questions. I turn the call back to you, Grace. Thank you.

Question-and-Answer Session

Operator

Thank you. [Operator Instructions] Presenters, there are no questions at this time. You may proceed.

Candace Formacek

Okay. Thank you very much, Grace, and thank you all for joining us on our call today. Goodbye.

Operator

Ladies and gentlemen, this concludes today’s conference call. Thank you all for joining. You may now all disconnect.





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Ultralife Corporation’s (ULBI) CEO Michael Popielec on Q2 2020 Results – Earnings Call Transcript


Ultralife Corporation (NASDAQ:ULBI) Q2 2020 Earnings Conference Call July 30, 2020 8:30 AM ET

Company Participants

Jody Burfening – Lippert/Heilshorn & Associates, Inc.

Michael D. Popielec – CEO and President

Philip A. Fain – CFO, Treasurer, and Corporate Secretary

Conference Call Participants

Gary Siperstein – Eliot Rose Asset Management

Operator

Good day and welcome to the Ultralife Corporation Second Quarter 2020 Earnings Release Conference Call. At this time, for opening remarks and introductions, I’d like to turn the call over to Ms. Jody Burfening. Please go ahead.

Jody Burfening

Thank you, Anita and good morning everyone and thank you for joining us this morning for Ultralife Corporation’s Earnings Conference Call for the second quarter of fiscal 2020. With us on today’s call are Mike Popielec, Ultralife’s President and CEO, and Phil Fain, Ultralife’s Chief Financial Officer. The earnings press release was issued earlier this morning. If anyone has not yet received a copy, I invite you to visit the company’s website ultralifecorporation.com, where you’ll find the release under Investor News in the Investor Relations section.

Before turning the call over to management, I would like to remind everyone that some statements made during this conference call contain forward-looking statements based on current expectations. Actual results could differ materially from those projected as a result of various risks and uncertainties. These include potential reductions in revenues from key customers, uncertain global economic conditions, and acceptance of new products on a global basis. The company cautions investors not to place undue reliance on forward-looking statements, which reflect the company’s analysis only as of today’s date. The company undertakes no obligation to publicly update forward-looking statements to reflect subsequent events or circumstances. Further information on these and other factors that could affect Ultralife’s financial results is included in Ultralife’s filings with the Securities and Exchange Commission, including the latest annual report on Form 10-K and latest quarterly report on Form 10-Q. In addition, on today’s call, management will refer to certain non-GAAP financial measures that management considers to be useful metrics and differ from GAAP. These non-GAAP measures should be considered as supplemental to corresponding GAAP figures. With that, I would now like to turn the call over to Mike. Good morning, Mike.

Michael D. Popielec

Good morning, Jody and thank you everyone for joining the call. Today I’ll start by making some brief overall comments about our Q2 2020 operating performance, after which I’ll turn the call over to Phil who will take you through the detailed financial results. When Phil is finished, I’ll provide an update on the progress against our 2020 revenue initiatives, and then open it up for questions.

For the second quarter of 2020, in the face of ongoing market, supply chain and operational headwinds due to the COVID-19 pandemic, Battery & Energy Products core revenues were up organically 23% year-over-year, driven by strong increases in both our medical and government defense revenues. When combined with the three acquisition revenues, B&E nearly fully offset the expected decline in Communication Systems year-over-year quarterly revenues, as existing Communication Systems contracts under the U.S. Army’s network modernization initiatives reach completion. Total company Q2 revenues were within 3% of the prior year and Q2 adjusted earnings per share were $0.13 per share. The team built on the momentum from Q1 and delivered solid sequential improvements in revenue, up over 10% quarter-to-quarter and operating profit and earnings per share each up over 55% quarter-to-quarter.

Regarding the COVID impact, as an essential supplier to the end-markets in which we serve, our workforce make quick adjustments to customer changes, such that the areas in Q2 where COVID issues result in a revenue decreases were almost entirely offset by areas where COVID demand led to revenue increases. This resulted in a relatively neutral net financial effect in terms of revenue and operating profit. Although difficult to quantify, the other areas where we saw an impact from COVID was a lengthening in time to receive supplier and customer responses to complete transaction processes, as well as in the customer testing the new products, which is understandable given the large mix of people working out of their homes versus their work offices and/or testing facilities. In a few minutes, I’ll give you further information on our revenue initiatives but first, I’d like to ask Ultralife’s CFO, Phil Fain, to take you through additional details of the second quarter 2020 financial performance. Phil?

Philip A. Fain

Thank you, Mike, and good morning everyone. Earlier this morning we released our second quarter results for the quarter ended June 30, 2020. We also filed our Form 10-Q and Form 8-K with the SEC this morning and have our updated our investor presentation, which you can find in the Investor Relations section of our website. I would like to thank all those that helped make this happen. For the second quarter, consolidated revenues totaled $28.6 million, representing a $0.8 million or 2.8% decrease from the $29.41 million reported for the second quarter of 2019. The year-over-year variances reflect a significant increase in battery sales across diversified end markets, offset by lower communication systems sales, reflecting the completion of contracts. We estimate that the net financial impact of COVID-19 was neutral to our financial results for the second quarter.

Revenues from our Battery & Energy Products segment were $24.0 million, an increase of 18.4% over last year attributable to a 71.7% increase in medical battery sales, and a 49.8% increase in government defense sales, partially offset by a 33.7% decline in oil and gas market sales. U.S. government and defense sales for the second quarter were at the highest quarterly level in over five years. The sales split between commercial and government and defense was 67/33, compared to 74/26 for the 2019 second quarter, and the domestic to international split was 59/41, compared to 53/47 last year, driven by the higher domestic government and defense sales. Revenues from our Communication Systems segment were $4.5 million, a decrease of 50.3% from last year. The decrease reflects higher 2019 shipments of mounted power amplifiers to support the U.S. Army’s network modernization initiatives under delivery orders announced in October 2018. These contracts were completed in the second quarter of 2020.

On a consolidated basis, commercial sales increased 7.5% and government defense sales decreased 13.7% from the 2019 period. The commercial to government defense sales split was 57/43 versus 51/49 for the year-earlier period, demonstrating the continued success of our revenue diversification strategy. Our consolidated gross profit was $8.0 million, compared to $8.9 million for the 2019 period. As a percentage of total revenues, consolidated gross margin was 27.9% versus 30.2% for last year’s second quarter. Gross profit for our Battery & Energy Products business increased 6.6% to $6.0 million, from $5.7 million. Gross margin was 25.1%, a decrease of 280 basis points from 27.9% reported last year, reflecting incremental costs in 2020 associated with the transition of a multitude of new products to higher volume production. For our Communication Systems segment, gross profit was $1.9 million, a decrease of $1.3 million or 39.7%, compared to $3.2 million for the year-earlier period. Gross margin of 42.8% improved 750 basis points from 35.3% last year, primarily due to efficiencies and improved productivity in the production of vehicle amplifier-adaptor systems for the U.S. Army.

Operating expenses totaled $5.7 million compared to $5.8 million last year, a decrease of 2.6%. Non-recurring expenses of $0.2 million for the acquisition of SWE were included in the second quarter of 2019. As a percentage of revenues, operating expenses were 19.8% for both the 2020 and 2019 periods. Operating income for the second quarter of 2020 was $2.3 million compared to $3.0 million for the 2019 period, a 24.6% decline, reflecting the flow-through of lower year-over-year sales for Communication Systems. And operating margin was 8.0% for the 2020 period versus 10.3% last year, driven by the lower gross margin for our Battery business. Adjusted EBITDA, defined as EBITDA, including non-cash stock-based compensation expense was $3.3 million or 11.6% of sales, compared to $4.1 million or 13.9% for the 2019 second quarter. On a trailing 12-month basis, adjusted EBITDA is $11.6 million or 10.2% of sales.

Our tax provision for the second quarter was $499,000, compared to $676,000 for the 2019 period, computed at statutory rates while excluding the benefits of our net operating losses and tax credit carry forwards for GAAP reporting purposes. Accordingly, our reported tax provision for the second quarter is based on an effective rate of 22.9%, while utilization of our deferred tax assets will drive the tax provision down to $108,000 or 5.0% while we actually pay our taxes. We expect that the net operating losses and tax credits included in our deferred taxes will offset all U.S. taxes for the foreseeable future. Including the interest expense and debt incurred to fund our 2019 SWE acquisition and using the 22.9% effective tax rate, net income was $1.7 million or $0.10 per share on a diluted basis for the 2020 second quarter. This compares to net income of $2.7 million or $0.14 per share on a diluted basis for 2019.

We utilized adjusted EPS to reflect actual cash taxes paid or to be paid and defined adjusted EPS as EPS, excluding the provision for non-cash U.S. taxes, expected to be fully offset by our net operating loss carry-forwards and other tax credits. As noted in the supplementary table in our earnings release, adjusted EPS on a diluted basis was $0.13 per share for the 2020 second quarter, compared to $0.18 for the 2019 second quarter. For the first six months of 2020, fully diluted adjusted EPS of $0.21 was up 4% over 2019. Ultralife ended the quarter with a strengthened balance sheet and enhanced liquidity, with cash on hand of $8.4 million, working capital of $50.5 million, and a current ratio of 4.5.

During the second quarter, we utilized cash generated from strong EBITDA, accounts receivable collections, and inventory reductions to reduce our debt by $6.1 million or 36.1%, and our accounts payable balance by $4.0 million or 33.8% since the end of the first quarter. We also deployed our increased operating cash flow for investments in test equipment to meet the increased demand for our power supplies for ventilators, respirators, and infusion pumps. As we navigate through these challenging times, we intend to carefully manage our liquidity to fund organic new product development, strategic capital expenditures and M&A, while further reducing our debt. As a result, we remain well-positioned to weather the storm, while continuing to invest in growth initiatives and staying focused on releasing the full leverage potential of our business model. I will now turn it back to Mike.

Michael D. Popielec

Thank you, Phil. During the quarter, we continued to advance our revenue growth strategy, which presently consists of the following three elements; market and sales reach expansion primarily through diversification, new product development and multi-generational product planning with strategic CAPEX when appropriate to drive competitive advantage, and a disciplined approach to acquisitions to quickly gain scale and obtain market access, technology, new products, and skilled resources.

At our Battery & Energy Products business, market and sales reach expansion is about diversifying more into the global commercial and international government defense markets to lessen our revenue fluctuation, as a result of lumpiness in our core U.S. government defense business. One of our first commercial diversification focus areas was medical, an end-market of mission-critical niche applications, competitive differentiation based on quality and reliability, and long-term high-value proposition customer relationships. When we initiated our diversification strategy in 2011, medical represented approximately 3% of total company sales. In Q2 2020, it represented approximately 33% of total company sales. We continue to be the beneficiary of our diversification in the medical, as we currently find our battery and charger products well positioned in devices serving several critical areas of a current COVID-19 crisis. We saw particularly strong demand from existing customers for applications and ventilators, respirators and infusion pumps.

In Q2 2020, our medical revenues were up over 70% year-over-year, bringing our nine-year medical revenue compounded annual growth rates to 33%, including the acquisition of Accutronics in January of 2016. In fact, Accutronics saw record revenues in Q2 2020, up 45% year-over-year driven by strong demand for its medical battery packs. Looking more closely at Q2 2020, core business key medical devices, battery and charger product shipments, were made for a wide range of applications including breathing devices, infusion pumps, digital X-ray, and surgical robots. We also received new delivery orders for existing customer blanket and/or multiyear agreements, which totaled $2.1 million.

Regarding Southwest Electronic Energy Corporation or SWE, acquired in May of 2019, in addition to shipping its core oil and gas and subsea electrification products, during Q2 the talented SWE team stepped up to successfully manufacture and deliver on a short cycle turnaround $1.7 million in medical battery packs for a respirator application serving the COVID-19 response. This also included part of a $1 million follow-on order which will be completed in Q3. Not only did SWE fulfill a key customer need, they also demonstrated their capability in medical products, thereby expanding further our revenue growth opportunities in medical end markets. For the recently completed Q2, its fourth complete quarter as part of our Ultralife, the SWE acquisition provided 17% of total company sales and was once again EPS accretive. At B&E, with the strong contribution of medical and now including SWE, our global commercial and international government defense market revenue mix represented 59% of our total company sales, a solid indication of the diversification which has helped us mitigate the lumpiness and unpredictability in B&E revenues from the U.S. government’s defense market.

Finally, regarding B&E’s U.S. government defense customers, which includes transaction directly to the various DOD entities, as well as through OEM Primes, in Q2 2020, revenue was up 55% year-over-year and represented approximately 25% of total company sales. In addition to solid OEM radiobiology shipments, during Q2 we began shipping the recent $4.8 million, 5390 DLA spot buy award with the balance expected to ship throughout Q3 and Q4. We also received a small follow-on five-year IDIQ Award for our 9 Volt battery, with the maximum value of approximately $900,000. Looking ahead, the next-generation 5390 and 5790 primary batteries under the $21 million and $49 million DLA IDIQ Awards respectively, are now entering battery build for the final first article testing, which is expected to begin in the August-September timeframe. New product development and multiple generation of product planning remains a fundamental part of our organic growth strategy. Not only does this keep our products current with market needs, it also gives us the opportunity to collaborate and remain close with our customers and provide value add.

Looking at Battery & Energy Products from a new product development perspective, in Q2 2020 15% of revenues were from products introduced less than or equal to three years ago. In the second quarter of 2020 progress was made across numerous projects with examples including continued shipments of our first public safety radio batteries, with two additional public safety batteries entering production in Q3, starting production and shipments of a new digital X-ray battery, finalizing the validation of a new ventilator battery pack expected to start low volume production in Q3, and shipping the first 60,000 Thincell batteries for a vital signs monitoring application. We also continue to deploy strategic CAPEX to bolster our competitive differentiation. In our Newark, New York, USA, facility where our $4.3 million capital investment is underway, in Q2 we successfully completed UN testing of our new premium 3 Volt product, low volume production is underway and we began shipping more samples to customers. Today, we have shipped samples to over a dozen initial potential customers and we expect this number will continue to ramp up in Q3 and Q4.

Our initial single shift capacity is approximately 1 million cells per year, with the planned line enhancements still underway and expansion to a multi-ship operation, we expect our capability to increase to almost ten times that amount within the year. This new product provides customers with world-class product performance, safety and a competitive price-value proposition as well as a supply chain proximity and quality of being made in the USA. It will serve the rapidly growing IoT wireless devices market, as well as next-generation 3 Volt smoke alarms, asset tracking devices, and metering. With some initial cell applications targeting specialized illumination and medical applications, we are also very excited about the opportunity to offer customers new customized battery packs incorporating this new 3 Volt cell. Separately in China, we also have a new locally manufactured lithium manganese dioxide 3 Volt cell, which is now shipping to global customers.

We continue to make progress on our plan of chloride cell upgrade project in China, involving numerous process improvements which will help us expand our total available market with newly identified commercial and industrial applications. Also included, our updates to our cell-formulations and designs, equipment and facilities. Samples of the new high-rate products began shipping to customers at the end of Q2, with the low-rate products expected to start sampling in Q3. Our goal is to produce the highest value proposition, best quality and safest products in which every one of our global locations best serves the supply chain of a particular end-market and our OEM customer. At Communication Systems in Q2 2020, new product development revenue from products less than or equal to three years old represented approximately 63% of Communication Systems revenues, including final shipments of vehicle amplifier adapters and power amplifiers for the U.S. Army’s network modernization initiatives from previously awarded contracts. Bottom line contract opportunities are anticipated later in 2020 and/or into 2021, after operational tests and evaluations are conducted by the U.S. Army’s Handheld, Manpack and Small Form Fit and Leader Radio programs. Looking ahead, Communication Systems remains positioned well for these opportunities within the domestic military radio market, through partnerships with prime radio OEMs and by providing products supporting both single and two channel Handheld and Manpack ancillaries and integrated state-of-the-art solutions.

Regarding the system integration of cutting-edge server technology discussed during the last few earnings calls, throughout Q2 Communication Systems has advanced the development and building of system integration components. We have delivered three variants to support a broad range of operational requirements, from a small technical team support to full command center integration. These systems are undergoing evaluation and testing with potential customers and initial fielding of sold units. A new initiative for a dismounted configuration is moving from concept to design activities, with discussions ongoing with stakeholders and wholesaler potential for a broad array of commercial and government applications. Communication Systems continues to be optimistic in this emerging growth area and OEM relationships, as expected demand increases throughout 2020.

Overall, OEM engagement for Communication Systems remains the highest priority and continues to be strong, providing ample new product development initiatives for integrated systems and amplifier platforms, product support for fielded products, and new business development to meet emerging radio capabilities being fielded globally. In closing, in Q2 of 2020 we were delighted that with a carry-over from Q1 of the operating complexity and market uncertainty related to the COVID-19 pandemic, our employees globally remain safe, stayed focused, and delivered improved revenue, operating profit and EPS over the first quarter. For the first half, total company operating profit is up year-over-year by 5%, while the year-to-date total company year-over-year revenue is up over 12%, and first half adjusted EPS is up 4%. Obviously, the ongoing COVID-19 breakout brings a significant amount of market uncertainty and supply chain challenges. That said, as demonstrated in the first half, the teams are working hard to overcome the hurdles and have positioned us to continue to strive for another year of profitable growth in 2020.

Looking forward, with the initial announced tranches of the Communication System contracts for the U.S. Army’s network modernization initiatives completed, the near-term focus will be on pursuing follow-on and new program awards and a number of smaller transactions while targeting several new active OEM Manpack radio projects, several integrated computing solution opportunities, as well as developing next-generation amplifier prototypes. At B&E due to the COVID-19 response, we see the present surge in medical revenue continuing near-term, which is helping to offset the current softness in our oil and gas revenues. Activity levels overall from the various Defense Department contracting channels and global OEM primes remain positive. Through the end of this year and into next year, we are also very excited to realize the increasing impact of other new revenue streams coming online, such as from new public safety radio battery packs, the new 3 Volt product line, the new ER product line, the smart UN battery product. The 5790 CFX blend primary battery and several other new Thincell, medical, and subsea electrification application battery packs.

The COVID-19 pandemic not withstanding we aim to grow the business with profitable revenues each and every year. We like the fundamental nature of the main industries we serve military defense, energy, and medical and believe that these end markets provide us with a level of durability and resiliency in good times and bad. In fact on an annual basis, the last five years running, we’ve achieved both revenue and operating profit year-over-year increases and we are targeting efforts to do so again in 2020 despite the coronavirus. We will continue to develop new products that support new revenue streams, and we will continue to pursue acquisitions where we can quickly gain scale and achieve further operating profit leverage. We are fortunate that our strong balance sheet, solid cash flow from operations, proven integration methodology, and this put into our business model give us this flexibility. Operator, this concludes my prepared remarks and we’d be happy to open up the call for questions.

Question-and-Answer Session

Operator

Thank you. [Operator Instructions]. And now, we will take our first question from Gary Siperstein from Eliot Rose Wealth Management. Please go ahead.

Gary Siperstein

Hi, good morning guys. Congratulations on another solid quarter.

Philip A. Fain

Thank you.

Gary Siperstein

My first question is, I’ve been on some conference calls for some of the prime defense contractors and that said on various calls, this is more than one company that they had been able to get from DoD some reimbursement on COVID expenses. I know you’re not a prime contractor but have you been able to get any compensation for your COVID expenses, I think they cost you $0.03 in the first quarter?

Philip A. Fain

Yeah, that’s correct, Gary. We reported $0.08 of EPS in the first quarter and it cost us $0.03. COVID cost us $0.03. The $0.03 that we speak of is most directly associated with the five-week shutdown of our China operation. And it was unabsorbed overhead and all of the expenses of keeping the facility intact with nobody able to do any work. So we’re not going to getting any reimbursements from the U.S. Department of Defense regarding that. Where the U.S. Department of Defense has been extremely helpful is the timing of their reimbursements and the direct contracts that we have with the DOD. The payments as — I think we may have talked about this before, usually we expect 30 days. We’re seeing reimbursement in a much quicker pace than that, which is always greatly appreciated. But that is really the extent of the assistance that we’re receiving in addition to the plethora of orders that we’ve seen coming through.

Gary Siperstein

Okay. And they’ve also mentioned on some of these calls with the primes that there are subcontractors, I guess as you just mentioned that sell directly to the DoD but these primes are paying their subcontractors much quicker. Are you seeing that also from some of your customers in addition from DOD?

Philip A. Fain

Yes, we are definitely because when you’re producing a product for a critical application, rule one is keeping your supply chain intact from the customer’s standpoint and they’re certainly able to do that and it puts us in a position where we’re able to keep a positive cash GAAP which is always the goal of a prudent careful cash management.

Gary Siperstein

Okay. And I know you had your hands full with COVID and digesting SWE, but I’m just curious what the pipeline looks like on M&A, have prices come down, are you seeing more companies that blocked previously due to price getting more realistic, and have more companies come on the market for sale in light of the recession and COVID?

Michael D. Popielec

Yeah, this is Mike, we’re still very active in the M&A area. We have multiple discussions given in any given time. We continue to look for companies that the day two of after we own them they’ll still continue to grow organically. There’s a clear roadmap to return and exceeding of our existing operating margin rate that are EPS accretive in the first year and that there is a reasonable return on investment overall. And so applying that criteria, we continue to be very active, multiple discussions in any given time, and as I’ve mentioned I think on previous calls that it takes several years to get somebody to actually get to the point where they’re willing to sell. But we like our position. We like our profitability. We like our cash flow. We like our access to capital and we’re certainly very, very interested in doing acquisitions and we don’t have anything to announce today and we wouldn’t until we’re actually in a position to close and having closed the deal before we make an announcement, but it’s still a very important part of our overall growth strategy.

Gary Siperstein

Okay, thank you. And in terms of the balance sheet, you guys have done a marvelous job on that. It seems like in the first six months of the year cash is up about a million bucks, payables are down about a million to million and a half and long-term debts almost down $7 million. Cash is just about equal to long term debt. With that being said, is there any appetite for stock buybacks with the stock trading at book value, with that solid first half?

Michael D. Popielec

No, our options continue to be on the table, Gary. We have said before, sort of our priorities are for organic growth first including CAPEX, acquisitions, as we just talked about what our interest were, and that if we still should have excess funds available that we don’t want to have sit idle we would consider stock buybacks. But at this point we’re not talking about anything like that.

Gary Siperstein

It’s been a while Mike since we’ve had any announcements on major contracts, I mean, you did have the major contract with Thales and then a year or two or two ago or couple of years ago, you had a bunch of IDIQs in a row, but it’s been quiet since then. You’ve mentioned smaller orders here and there. What does the pipeline look like on potentially larger contract awards and announcements?

Michael D. Popielec

I mean it’s a good plan. I mean I was looking back and there were specific announcements in 2016, 2017, 2018, 2019 and a lot of those were IDIQs. And I think those are obviously the first step in terms of getting revenues from one of our largest customers being the DoD, but I think another really important aspect of that is, is that it really doesn’t count against the ledger until we actually ship revenue against it. So whereas we — I think we have right now close to $100 million of IDIQs, our intense focus is on getting those throughout the first article testing and all the other requirements of the government so that we start getting delivering orders and showing revenue. That being said, we have some large projects that we’ve talked about in my prepared remarks, particularly for Communication Systems and we don’t have any clear visibility to exact timing of when those contracts would hit. There’s something we spend a lot of our time on. So we would anticipate larger contracts in the future. But in the meantime, we’re trying to deliver for revenue realization the ones that we have.

Gary Siperstein

Okay, thanks for that. And finally, just a little bit of commentary on my part. I just want to congratulate you guys for doing an amazing job these last five years through thick and thin, the economy is up and down, the DoD fickleness, and now COVID, you guys have managed to increase revenues, increase earnings, increase book value, mind the balance sheet, etcetera wonderfully for the last five years. But that being said, we’re trading at book value where we have $0.21 in six months earnings, $0.24 adjusted for COVID. We’re annualizing over $0.40 in earnings, should be at $0.41 last year. Next year the IDIQ as you mentioned $100 million, the IDIQs would start contributing. Next year, 3 Volt will start contributing, next year, the Internet of Things will start contributing, next year the Leader Radio could go into full production from the LRIPs that it’s going on now. So you’re trading at like a 15, 16 current PE in the stock market that has a 21 PE with the S&P. And one could reasonably conclude with all those things I mentioned starting to contribute starting next year in a post-COVID environment where $0.50 to $0.60 in earnings or more is possible in 2021-2022, which would put us at about a 12 PE.

So, while I give you kudos on what you’ve done and accomplished, I think you guys have done a horrible job on Investor Relations, with all this potential and all the success over the last five years this stock shouldn’t be trading at book at 12 times forward earnings. So, I think you guys could seriously consider a new IR firm, you should consider getting an investment banker, you should consider hiring possibly a full time IR person, and you should start attending these virtual conferences where you don’t even have to travel. You’re part of the Russell 2000 now. You’re competing with 1999 other public companies that are looking for investor attention. So just to get a fair valuation on your company, I think as a function of getting that investor attention and besides the 2000 companies in Russell 2000, there’s another 5,000 or 10,000 other publicly traded small companies. So, I think if you picked up that effort, we would have a much better valuation on the company which would give you guys, first of all, it’d be nice for your shareholders to have the company properly valued for all you’ve accomplished and all the potential, but also obviously having the currency at a higher valuation, it gives you more options with M&A. So, I hope you’d consider some of those ideas.

Michael D. Popielec

Thank you very much. Really appreciate the input Gary.

Gary Siperstein

Alright, guys. Thanks very much and congratulations again.

Michael D. Popielec

Thank you.

Operator

Thank you. [Operator Instructions]. It appears there are no further questions at this time. Mr. Popielec, I’d like to turn the call back to you for any additional or closing remarks.

Michael D. Popielec

Alright, operator. Thank you very much and thank you once again for joining us for our second quarter 2020 earnings call. We look forward to sharing with you our quarterly progress in each quarter’s conference call in the future. As Phil noted and I’d also like to note that we updated our investor presentation on our website. So, please check that out and everybody have a safe and a great day.

Operator

This concludes today’s call. Thank you for your participation, you may now disconnect.





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Scientific Games Corporation’s (SGMS) CEO Barry Cottle on Q2 2020 Results – Earnings Call Transcript


Scientific Games Corporation (NASDAQ:SGMS) Q2 2020 Results Earnings Conference Call July 23, 2020 4:15 PM ET

Company Participants

Trent Kruse – Senior Vice President, Investor Relations

Barry Cottle – President and CEO

Mike Eklund – Chief Financial Officer

Conference Call Participants

John DeCree – Union Gaming

Barry Jonas – SunTrust

Brad Boyer – Stifel

Chad Beynon – Macquarie

Ryan Sigdahl – Craig-Hallum Capital Group

Operator

Good afternoon, ladies and gentlemen. And welcome to the Scientific Games 2020 Second Quarter Investor Conference Call. At this time, all participants are in a listen-only mode. [Operator Instructions] A brief question-and-answer session will follow the formal presentation. [Operator Instructions] Please note this event is being recorded.

Now, let me turn the call over to Trent Kruse, Senior Vice President of Investor Relations for Scientific Games. Mr. Kruse, you may begin.

Trent Kruse

Thank you, operator, and good afternoon, everyone. During today’s call, we will discuss our second quarter 2020 results and operating performance, followed by a question-and-answer period. With me this afternoon are Barry Cottle and Mike Eklund.

Our call today will contain statements that include forward-looking statements under the Private Securities Litigation Reform Act of 1995. These statements involve certain risks and uncertainties that could cause actual results to differ materially from those discussed during the call.

For information regarding these risks and uncertainties, please refer to our earnings release issued earlier this afternoon, the materials relating to this call posted on our website and our filings with the SEC.

We also will discuss certain non-GAAP financial measures. A description of each non-GAAP measure and a reconciliation of each non-GAAP measure to the most directly comparable GAAP measure can be found in our earnings press release, as well as in the Investors section on our website.

As a reminder, this conference call is being recorded. A replay of this webcast and accompanying materials will be archived in the Investors section of our website at scientificgames.com.

Also, supplemental reference slides are available on our Investor Relations website. While management will not be speaking directly to the slides. These slides are meant to facilitate your review of the company’s results and to be used as a reference document following the call.

Now, let me turn the call over to Barry. Barry?

Barry Cottle

Thanks, Trent. Good afternoon, everyone, and thanks for joining us. I want to start by recognizing my colleagues. I am so proud of the way our team has stepped up to help each other, our partners and our company.

We are navigating the current environment incredibly well as evidenced by our strong cost containment and cash management, which allowed us to significantly outperform our cash flow expectations for the quarter.

This better-than-expected performance is a testament to our team’s ability to effectively manage our business in the short-term, while also setting ourselves up for success as the economy begins to reopen. We are very aware that there are still many unknowns in the coming months, and therefore, will be cautious in how we think about bringing cost back to our business.

Ultimately, though, we are optimistic in our outlook for the rest of 2020 and beyond. We have structured the business to operate effectively through any environment as we have demonstrated by our ability to continue to drive results across our business, while operating through this unprecedented situation. But we have also positioned ourselves to emerge stronger, more nimble and ready to win.

Today, we will share, first, that we are in a very solid financial position, including over $1.1 billion in liquidity following our recent debt offering.

Second, the actions that we are continue to take to effectively manage our portfolio of assets and best position ourselves for the future.

And finally, demonstrate the strength and true competitive advantage of our diverse business that has allowed us to deliver meaningful results throughout the crisis and had us positioned to drive strong results as we look ahead. We are exiting this crisis with improved liquidity and enhanced product line, an incredible team and ready to pursue numerous growth opportunities we have in front of us across all of our segments.

Now before I turn the call over to Mike Eklund, I wanted to take a minute to welcome him to our team. We are very fortunate to have Mike on Board. He brings a wealth of experience in financial and operational leadership and a passion for aligning all aspects of the company’s finance and operations with its core business model. Mike has just jumped right in and identified several opportunities for us to continue to enhance our operations and deliver improved cash flow and profitability.

Following Mike’s comments, I will come back to discuss how we are looking ahead to drive strong results across our business. Mike?

Mike Eklund

Hey. Thanks, Barry, and good afternoon, everyone. It’s great to be on the call today. It’s interesting as I reflect back on my decision to join the Scientific Games team, I was certainly excited at the time about the multiple growth drivers across the many business units we have here.

I was also excited about the clear opportunity to enhance operational effectiveness and the many things that we do and if you do those things right, it should drive higher margins and cash flow, and I could see that from the outside looking in. And ultimately, if you do all those things and you do them well, we should be able to create some real value for our shareholders and unlock some potential, at least that I see in the business.

What I can tell you and I am happy to report as 45 days into the role, I am more convinced than ever that I made a great decision to join the company and I could not be more excited to be here. For some of you that may know me on the phone and from a prior life, it’s probably no secret that this kind of investment thesis is exactly what I like to do and exactly what I have fun doing.

And as you might imagine right away, my focus will be on a couple of key things. Number one, delivering predictable results with everything we do. Number two is filling a set of balanced priorities across liquidity growth and profitability. Number three, achieving operational excellence across the full cost structure of the firm and then, of course, de-levering.

With that, I would now like to turn to four key headlines that I saw for Q2 as I reflected on the quarter, after that I will give a brief update on the financial and business unit results. With that, let’s jump right in and start with the headlines for Q2.

First with liquidity, we have a strong liquidity position with $1.1 billion in available liquidity following our July refinancing, which we topped up by $200 million or so as all of you know. We also exceeded the May guidance we have provided for Q2, delivering a net cash outflow of minus $16 million versus guidance in a range of negative $70 million to $90 million. So really nice performance by the team there.

When all was said and done, our team has generated plus $5 million of positive free cash flow in an otherwise extremely challenging operating environment. So it’s a great job by the team and we could not be more appreciative of the work that they have done.

Now the second highlight, we completed the refinancing of our notes in 2021 as well. As a result, we have no significant maturities due until 2024. We are pleased with our timing in the market. On that refinancing, I think many of you that are on the phone for your support in getting it done. In fact, the widespread support that I saw for Scientific Games was both encouraging and great to see, and again, I just want to tell you thank you for that.

Third highlight is the breadth of the portfolio which really helped us balance our results for the quarter. While we all know the Gaming business was materially impacted by the widespread casino closures during Q2, the stay-at-home orders actually have the opposite effect by generating material upside for our SciPlay business and within the Digital business on the iGaming side in particular again material upside. Great to see the balance of the portfolio working to our advantage in this tough market.

Our Lottery business also proved its resiliency and held its own for the quarter. Of course, we got off to a slow March and April, but recovered really nicely in May and June, and we see that momentum carrying over into Q3 and Q4, and we are comfortable with where our Lottery business is going into the second half of the year.

The fourth headline and the final headline, our teams reduced $150 million of cash expenses in the quarter. As we worked through a very difficult business environment, our teams were able to reexamine all aspects of the business. Importantly, we now expect a meaningful portion of these cost measures to result in permanent savings in 2021 and beyond as the teams has set to rethink the way we do business now and in the long-term.

Now, let’s look at our quarterly P&L results. The impact of COVID-19 disruptions that resulted in temporary closures of casinos globally and a lower level of Lottery ticket sales drove a 36% decline in our revenues to $539 million.

The lower revenue resulted in AEBITDA declining to $121 million, which compares to $335 million in the prior year. The $121 million of AEBITDA did include a $33 million charge in our Gaming segment related to receivables and inventory valuation and you will see that in our disclosures.

In response to the business environment, we reduced our operating expenses, as you have seen, by $122 million or 17% to $595 million. We will continue our focus on expense controls and reductions and will only layer those costs back into the business as we see revenue ramping back up.

Our net loss for the quarter was $198 million or $2.15 per share versus $75 million or $0.83 per share in the prior period year.

Turning to our balance sheet and cash flows, we delivered $52 million in cash flow from operations, and as I mentioned earlier, generated $5 million in free cash flow. Our cash flow upside relative to our May guidance was primarily due to better than expected collection and stronger performance in some of our business segments that we have already talked about.

Our teams did an outstanding job managing the things that they largely control and delivered a $32 million source of cash from working capital improvements in the quarter. In addition, we eliminated all non-essential expenses, implemented workforce cost savings measures and deferred all non-critical CapEx.

From CapEx it’s important to say and it was important for me as the new guy coming in, we did that with an eye towards continuing to invest in our future growth and efficiency opportunities. We will continue to proactively assess ways to streamline our cost structure and make Scientific Games as efficient as possible.

Our CapEx spend this quarter was $39 million, compared to $65 million last year. For 2020, we are now planning for capital expenditures to be in the range of $210 million to $240 million or $90 million below our original guidance for 2020. With all of these actions, our liquidity, as we have talked about is over $1.1 billion following our recent notes offering.

Finally, we ended the quarter with a net debt leverage ratio of 8.6, and as a reminder, we previously amended our credit agreement to obtain relief on the net first lien leverage ratio covenant through and including Q1 2021. Looking ahead, we are committed to significantly reducing our debt leverage ratio, delivering sustainable profitable growth and generating strong cash flow.

Now I will quickly turn to our business unit performance, starting with SciPlay. SciPlay revenue was up 41% to $166 million. While AEBITDA increased 80% to $60 million, driven by record KPIs across the Board. It was great to see the productivity dropping through to the bottomline in the SciPlay business for sure.

Our Digital revenue increased 6% to $73 million, while AEBITDA increased 67%. Again, really nice productivity dropping through to the bottomline. We continue to win builds and stand up new customers in both Gaming and Sports and our U.S. iGaming revenue was up 135% in the second quarter demonstrating the significant growth potential we have in the U.S. market as it continues to ramp.

Our Lottery business was down 10% to $290 million, while EBITDA was down only 6% to $97 million. The margin upside was driven by increased penetration of our higher margin SGEP revenue and lower expenses. In addition, in the last four-week period, domestic Instant Lottery Ticket sales are turning up over 20% from the prior year. Finally, we still expect to launch the Instant Ticket Lottery in Brazil later this year.

In Gaming our results were clearly impacted by global casino closures, but our team has positioned out business well, stay focused on our largest profit opportunities, significantly streamline the cost structure and are continuing to innovate for our customers through contactless and cashless solutions where we can leverage our industry leading systems business in over 500,000 connected slots to drive meaningful revenue in the future.

To wrap it all up, as we said before, we have over $1.1 billion in liquidity and plenty of runway in our debt maturity given our recent refinancing. We have right-sized the business appropriately to handle the current environment, while continuing to successfully position ourselves for the future. The teams are maintaining a critical focus on controlling expenses and we will only add that cost to the business as we — as the results warrant.

I feel optimistic that the lessons we have learned and the actions we have implemented while navigating this unprecedented environment will enable us to emerge as a more efficient business delivering increased cash flow that will allow us to achieve all the potential I see in the space.

Again, it’s great to speak with all of you today. I couldn’t be any more excited to be at Scientific Games and working with Barry and the talented team of leaders that he’s put together. Together, we will for sure unlock the true potential of Scientific Games.

With that, let me turn it back over to Barry. Barry?

Barry Cottle

Thanks, Mike. As you heard, we have and will continue to effectively manage through this crisis, but would also focus on current and long-term success across our business. Our focus remains on building a better, stronger and more efficient business for the future, and we are committed to providing market leading products and services to our customers across Gaming, Lottery and Sports betting both in retail and digital.

Our teams are clear on what needs to be done when today and in the future by delivering best-in-class products, focusing our strategies and accelerating our actions toward a more nimble and effective Scientific Games.

In Gaming, we are controlling what we can control by reducing our cost structure to create a leaner and more efficient organization, while also building out strategic long-term growth opportunities to drive greater share of wallet today and as we continue to emerge from the current crisis.

The team is focused on several areas including North American premium Gaming operations in North America and outright sales segments and commercializing products to innovate for our customers to drive operational efficiencies and provide significant revenue opportunities.

For premium Gaming operations, the team is working to grow the segment with a focus on driving commercial excellence with our top franchises, including the number one WAP game in the market, Dancing Drums Explosion.

To expand placement opportunities with Dancing Drums Explosion, customers may now select between three different cabinets, which includes the TwinStar V75, TwinStar Wave XL and now TwinStar J43.

To drive replacement sales within the North American sales segment, the team is focused on developing core products that will deliver proven content and competitive pricing with affordable hardware options.

The recently launched TwinStar Matrix and TwinStar 5 Reel Mechanical had strong constant roadmaps for both for-sale and Gaming operations segments. We are bringing a number of classic titles a number of classic titles forward to build customer competence around our content portfolio while also providing flexible pricing options for our customers.

We have also accelerated technology and products across cashless and contactless solutions that are gaining significant traction in the market as a result of COVID-19. Taking a mobile-first approach, the unified wallet product is powering a cashless gaming experience by giving players the power to instantly access funds to play slots and tables through a mobile app. Cashless solutions will help keep both team members and guests safe and it’s also cost effective for casino operators.

We have also developed the social distancing and automated game sanitation modules to support our customers by automatically enforcing social distancing among slot players, allowing players the access to reserve their favorite game during their visit and eliminating the manual task of searching for games that need to be sanitized by automatically identifying these games. These solutions are creating significant revenue opportunities for us and solving problems for our customers.

In addition, the pipeline and interest for the electronic table games segment remains strong. Sales have more than doubled in the past quarter and the order pipeline has seen a 3x demand increase since March. Quartz Hybrid launches in Q3 to further enhance the player experience within this product line.

Finally, the team continues to drive organizational improvement, reduce our cost structure and we are excited to have recently welcomed Melissa price as our new Senior Vice President of Global Gaming Operations as we continue to attract and retain the best talent in the industry.

In our Lottery group, we are seeing significant improvement in performance in recent weeks as the U.S. Instant product sales are surging. In fact, the U.S. Lottery market is up over 20% for Instant Game retail sales in the most recent four-week period versus last year.

We also continued to demonstrate an exceptional win rate on contract rebids, as evidenced by our recent renewals in multiple U.S. states and two recent internationally in Germany. As a reminder, following our elevation to the primary supplier in Connecticut, Scientific Games is now the primary supplier to all 10 of the top performing Instant Game lotteries in the world.

Building on the momentum we have seen across our Instant Games business is the outstanding results we are seeing in our SGEP program. States on the SGEP program outpaced industry sales growth by over 40%. In fact, Ohio switched to the SGEP program in July 2019 and it’s seen a 13% increase in ticket sales in their first year.

Five of the top 10 performing lotteries in the world are SGEP partners and we see continued opportunity to convert additional states to this program, where we provide a full Instant ticket category management program across product solutions, advanced logistics, retail optimization, and digital engagement.

Speaking of digital within Lottery, our iLottery solution is continuing to deliver outstanding results with the Pennsylvania Lottery. As you know, our iLottery launch in Pennsylvania is the most commercially successful iLottery launch in North America to-date, delivering total sales of $1 billion in under two years and it’s now on track to deliver over $1 billion in sales annually. We continue to expect to see iLottery adoption accelerates across states and we are incredibly well-positioned to benefit from these rapidly increased adoption levels.

In our Digital segment, we have significant momentum as we expect to announce another big partnership win in the very near future. We delivered four key launches over a four-week period in June, with two additional partners in the process of launch. This type of velocity demonstrates our significantly improved speed to market capabilities.

We launched Betfred in Colorado, Sports for the NLO, the Dutch lottery, which is a takeaway from the competitor. FireKeepers in Michigan, the first tried to launch in the state, demonstrating our market leading position as the state begins operations and we re-launched Dancing Drums [ph] on an improved tech platform. I would note that Dancing Drums and the NLO win demonstrates the power of one SG and our longstanding partnerships with the World Lottery Association operators.

As we look ahead, we will be watching sports with Golden Nugget in New Jersey and iGaming and sports with Golden Nugget in Pennsylvania and Michigan. And we are thrilled to support Golden Nugget as they look to significantly accelerate their Digital business across the U.S. especially in light of their public listing plans.

And in Michigan alone, we are extremely well-positioned between Golden Nugget, FireKeepers, FanDuel, and others who we are discussing our full suite of products with, and we expect all operators in the state will utilize our Gaming content.

As we have discussed before, the iGaming and Sports markets are expected to grow at incredible rates across the U.S., with iGaming expected to grow at a compound annual growth rate of over 65% and Sports expected to grow at an over 50% rate.

In fact, if you take New Jersey iGaming revenue and project out to a mature U.S. iGaming market, it implies a $22 billion GGR opportunity in the U.S. for iGaming alone and our partner Golden Nugget is targeting 10% share of this over $20 billion market, further highlighting our vast potential.

Looking at recent results across New Jersey, we have held 44% market share and our iGaming revenue in the state was up 1135 versus last year. With our unmatched OGS platform and market leading position in North America iGaming, no one is better positioned to take advantage of these expanding market opportunities where we can leverage our position to be the preeminent player in future iGaming expansion.

And in Sports, we are set for a second half recovery and are seeing significant demand within returned events such as European soccer leagues and racing. In fact, we saw a 44% year-over-year increase in bets placed on Royal Ascot day one.

Our technology helped pioneer Sports betting nearly 20 years ago and carries with it a platinum level reputation for scalability, reliability and robustness. We are the worldwide leader in delivering Sports technology and systems to regulated markets. We drive over 60% of the bets in the U.K., are leaders in many other regulated markets and are positioned to be the number one supplier in the U.S. market.

And finally, with SciPlay, we produced record results in the second quarter. We delivered significant and compelling enhancements to economies, game quality and live ops across our portfolio that allowed us to truly capitalize on the surge we have seen in player demand.

As a result, we generated record quarterly revenues of $166 million, up 40% to last year and our AEBITDA increased 80% to $60 million, also a quarterly record. ARPDAU increased 40% to $0.67, average monthly revenue per payer increased nearly 25% to $101.13 and payer conversion grew 80 basis points to 6.8%. All of these KPIs represent record levels and demonstrate the incredible position all of our games are in.

In addition to these great results, we also acquired casual game developer, Come2Play during the second quarter, adding a new genre of evergreen casual games and an incredibly talented team to our portfolio immediately expands our market beyond social casino apps and enables us to leverage our unique technology and strategies to drive player engagement and grow revenue. We are excited about our record breaking results in the second quarter and for our future given the strength of our games and the untapped growth opportunities we have ahead of us.

In closing, we are in a very solid financial position and we are continuing to effectively manage through this crisis and best position ourselves for the future. We are moving forward with improved liquidity and enhanced product pipeline and incredible team and we are ready to pursue that numerous growth opportunities we have in front of us across all of our divisions.

Now before we turn to Q&A, I want to quickly address the recent filing from our shareholders of MacAndrews & Forbes. We expect to work cooperatively with MacAndrews & Forbes as we always have and they consider the sale of it SG shares.

The sale consideration is at a very early stage and therefore we have no additional details to provide at this time and we will not be commenting further today. We will provide updates as appropriate and want to ensure that this process will not affect our business planning, decision making nor day-to-day management in any way whatsoever. The leadership team will continue to run the company and report to the Board.

With that, we are happy to take your questions. Operator, could you please open the line for questions.

Question-and-Answer Session

Operator

[Operator Instructions] The first question is from John DeCree with Union Gaming. Please go ahead.

John DeCree

Hi, Barry. Hi, Mike. Congratulations guys on the quarter. I don’t think we will see too many results from our sector that has positive AEBITDA — EBITDA and free cash flow, so congratulations on that. And Mike, it seems like you picked a good time to start, so we welcome you to the Sci Games team.

Mike Eklund

Thanks, John.

Barry Cottle

Thanks, John.

John DeCree

A lot of good stuff to talk about, Barry, so maybe I will just kind of start high level and kind of get your thoughts on long-term strategy as the world is just kind of changing on us in real time. So a number of your business segments are really shining here. You have highlighted most of them, I think, in your prepared remarks, whether it’s on Lottery results, demand for electronic tables, of course, SciPlay and iCasino. I wanted to get your view on kind of how sustainable some of this demand is on the other side of the pandemic, whatever that kind of new normal might look like, we are obviously experiencing a lot of growth right now. But what are your thoughts and views on the growth or at least this level of business demand sticking around whenever we get to hopefully the other side of this pandemic?

Barry Cottle

Absolutely. Thanks, John. And I think there may be two questions there, so let me tackle first the SciPlay and Digital piece of this and then talk a little bit about kind of the note on long-term — again comment on long-term strategy.

So, first of all, as you noted, we certainly saw benefits in SciPlay and Digital from the stay-at-home dynamic. However, it’s important to note that we had our games at SciPlay in incredible shape going into that and also being on the forefront of Digital Gaming allowed us obviously to truly capitalize on the surge in player demand as well.

And I think it’s also clear that I think the current environment has created significantly higher baseline for these businesses going forward, given the rapid player adoption of Digital that we have seen.

I’d also note that, if you take a look at iGaming, that market has grown in recent years. In New Jersey along with a land based market. So we think Digital has continued to have a lot of strong growth ahead as does land based gaming and they can grow in tandem. We have seen this in New Jersey, and obviously, in Pennsylvania with iLottery.

So we expect both of these businesses to continue to drive meaningful growth. So you are going to see growth in the addressable market, growth in consumer and adoption, growth in product, games, features and we think it’s a very healthy business in which we have a really strong position in.

And then in terms of our long-term strategy, I would say, I feel as confident today as I ever have about the positioning that we have created, our go-forward strategy. In fact, quite frankly, what’s happened is really reaffirmed to me the strength and competitive advantage of both our team and the diverse portfolio of businesses we have.

We structured the business to operate effectively through the environment and our leadership position created a lot of opportunities to deliver profitable growth today and sets us up nicely for the future.

So as you mentioned, our Digital business we lead the iGaming market today, and I mean, this past quarter delivered 135% iGaming revenue growth in the U.S. in this quarter alone. And then, if you look at the momentum that we have on the deal and launch front on Sports just reinforces our leadership position there as well. I don’t think anyone is as well-positioned as we are today or in the future to take advantage of the rapid growth that I think we are going to see in those markets.

On the Lottery front, as Mike alluded to, we are not only well-positioned, but also that business is so resilient as we saw in Q2 and we are now seeing the Instant ticket sales increase significantly. And if you look ahead, we are positioned to take advantage of new territory such as the Brazil launch or — and the unprecedented bid winning streak that we have now, the acceleration in adoption via Lottery and then the broader adoption of the SGEP program where we manage the full Lottery solution. So really strong kind of play there on the Lottery side.

On our SciPlay as we mentioned record growth in the quarter of 40%, which is 2x the market rate and AEBITDA at 80%, which shows the leverage that we have in that business at it scale and then add on top of that the recent acquisition of Come2Play we are now expanding beyond social casino into the casual game market, which again help enables us to continue to accelerate and grow that business going forward.

In Gaming, we have an amazing team just laser focus on driving greater share of the customer wallet through a compelled — it’s really compelling product road map and commercial approach both pre and post-COVID, while becoming leaner and more efficient with the business.

As you know, we can’t control or predict COVID but we can impact our market share we can impact our cost structure. And so we are extremely confident in Matt and team’s ability to deliver profitable market share growth in the quarters ahead.

When you look at all that and on top of this team’s reducing cost across the Board, enhance cash flow and create even more nimble efficient business overall. We believe that just enables us to be in a really nice position competitively and achieve our full potential and deleverage the business and generate strong results for all of our shareholders.

John DeCree

That’s helpful. I think you answered multiple questions in there, given there’s so much to talk about. But if I could sneak one short follow up in. You have been talking a little bit about some additional partnerships on the Digital front. It might be on the horizon and realized you probably can’t specify who or how flung along those are. But could you kind of qualify what a big partnership might be it for you? Is it a kind of multi-jurisdiction partner or does it go across, I can see the lens where it certainly would be a kind of a big partnership in your eyes if you could qualify?

Barry Cottle

Yeah. I think, no. That’s fine. I think, as you alluded and I also appreciate you highlighting the momentum we are having right now and that we booked the deals, as well as the launches. I think we launched four — we had four launches in the last four weeks and another two imminent.

We do have — on the open bet side or the Sports side of the business, we told everybody our playbook was to replicate our success that we have had in the U.K. by delivering the best, most reliable, proven, scalable and customizable product.

And over time, everybody is going to gravitate toward that and we are seeing that happen in the U.S., as people who had made original choices for somebody else are now switching over to us as they want to scale up, and then — and I think that’s worked out really nicely.

On the iGaming front, our OGS platform which kind of the Netflix, I would say, of the space, where we have a very rich — kind of feature-rich platform that attracts the top content studios that we bring to market in addition to our own IP. We can offer that as well and so it becomes kind of a must-have for people, operators entering that space.

We do have deals that we are not announcing today, but we have that are in the pipeline and imminent and I think as you alluded to kind of, yes, to all of the above, multi-jurisdictional, et cetera. So, we are happy with the momentum we are seeing in that side, and as I said, fortunate that the playbook that we had in place seems to be playing out.

John DeCree

Thanks, Barry. Thanks for taking all my questions. I will hop back into the queue.

Operator

The next question is from Barry Jonas with SunTrust. Please go ahead.

Barry Jonas

Hey, guys. Hey, Barry. Welcome Mike. I wanted to — I had a few questions, I wanted to start with the Gaming segment. Just curious what you are hearing now as you speak with customers first when the pandemic first really hit. When do you think customer budgets and purchasing levels could go back to pre-COVID levels?

Barry Cottle

Yeah. That’s a great a great question. Obviously, a challenging question just given the state of where we are at in terms of COVID and alike. I guess, the way I would answer this is, there’s a high degree of uncertainty, so everything obviously has to be caveated. However, based on the conversations we are having, we do expect to see more normalized level of spend in next year and we do believe the Gaming business will grow meaningfully in 2021.

If you look at kind of the view of the impact and recovery that we are seeing in the market, today we have got roughly 85%, let’s say, casinos open. And the early results are actually very encouraging when you see coin-in on a per day basis actually up significantly for the units that have been turned back on. So the initial consumer demand seems to be there and that seems to be moving forward.

In terms of — that’s how I’d kind of describe the market per se, in terms of us in particular, I think we are very fortunate in the sense that our exposure is largely tribal and regional, so that’s 95%. And we believe that the recovery in that space actually will be faster because that you don’t have the contingency on travel and tourism, it’s very much a local driven market.

And so we are always cautious but we are encouraged, I would say. And so, as I mentioned before, we can’t control or predict COVID, but what we can do is make sure our cost structure is set up appropriately and make sure we have the products and services lined up ready to take the greater share of wallet that we can when it does.

Barry Jonas

Well, that’s really helpful. But maybe just to drive home that point a little bit more. We are certainly seeing instances in some of the regional markets of second waves of cases. I am just wondering as you look at some of your real-time participation data or maybe even on the Lottery side actually. Are you seeing a tail off there or are those businesses holding despite any second waves?

Barry Cottle

Yeah. So a couple of things first so when you talk about the second wave. What we have seen actually is, there have been — remember that’s close to a thousand casinos opening up over the course of the country.

We have only seen a few, two to three that the casino that closed basically temporarily, but reopened obviously in Arizona, Oklahoma, and they have closed for a day or two, sanitized them and reopened. But we are still seeing the momentum of people cautiously continuing.

I think what people are at least what we are seeing and coming out in our discussions is, people ensuring that they are taking the right social distancing sanitation measures that will help them stay open and grow.

And obviously, I can — we have been — with the systems leadership position that we have, we have taken it upon ourselves to really try to come in with a set of products and services that will enable our operators continue to do that and we have created those — obviously the cash was in cargos which we have in the market now and ready and available.

But we also set up some sanitation and system type of products that enable people to turn on different machines, keep them off in order to keep people socially distanced by actually testing some surface and topical things.

And so the goal here is to try to keep that momentum going and leverage our systems position in order to give people tools in order to do that safely, because the goal is obviously — the other thing we can impact during this COVID time besides the wallet and cost structure is, we want to make sure we ensure our employees, our customers and our players are safe, right? And we always keep that very high on the list as well.

Trent Kruse

And Barry, this is Trent. I just would add to your point on Lottery. We called out the surge an instant ticket growth here over the last four weeks. But that’s been transpiring for longer than those four weeks and has been very consistent. So we are seeing those encouraging trend, and to Barry’s point, we are innovating for our customers at this point in time as well.

Barry Jonas

That’s great to hear as well. So just the last one for me, maybe to get Mike into the fray. I appreciate the remarks about the leverage from here. But any levers you would consider to sort of accelerate whether it’s asset sales, equity issuance, spinouts of a division, just curious to get any high level thoughts there?

Mike Eklund

Yeah. My initial reaction is it’s a little too early to tell. But, clearly, Q2, Q3 with all the uncertainty in the market, our approach has really been look let’s control what we control in this environment.

In this environment, we control the health, safety and well-being of our team members. We control keeping our customers satisfied with products, innovation, what they need when they need it. We can control cost and we control working capital.

Frankly, all of our attention has really been on that and Q2 was really kind of prepare for the worst hope for the best posture. As we go into Q3, which is really where our focus is now, it’s kind of cut over to cautiously optimistic for all the reasons that Barry said.

We see encouraging trends with kind of tribal and regional casinos around the Digital, the SciPlay business are doing well, Lottery, as Trent said, pretty tough March and April, but May and June kind of bouncing back recovering really nice, we feel great about the momentum there.

And so as those things start to stabilize, we are kind of postured either way we need to go. If things open up, we are going to lead in heavy and fast and we are ready to go. If they tighten back up, we will tighten back up with them and we have already got the cost controls in place. We have got the liquidity in place. We have got the headroom from a cash flow in place.

So really a lot of the focus up to this point frankly has been let’s just get things stabilized given the environment we are in and the reality of where we are. Again, tough environment that feel great about the work that the team has done. It’s been really impressive to see.

Coming in new, I can tell you this just from the outside looking in. I feel really good about the house of brands that we put together. I feel really good about the leadership team that Barry has put in place and my interactions with all of them so far have been extraordinarily positive, hardworking, focused dedicated really leading in on the right topics.

Clearly, when you look at the business with the new set of eyes from the outside and I see opportunities in the working capital cycle there will be a lot of focus on liquidity, cash flow payables, inventories, receivables, just leaning all of that stuff out and really making sure we get the best out of it.

Little too early to tell you exactly, I have some hypothesis that we are going to work through over the next 90 days. When you look at the way the company came together with a lot of acquisitions over time, a lot of things get left behind in terms of synergies, effectiveness, integration, et cetera. When you look at things like automation, digitization of everything we do internally just like we do externally, I see a lot of opportunities there.

So as we get ready for 2021, we kind of get out of the rush of the environment we are in now. The leadership team and I have had a lot of conversations around what does 2021 look like and what does the next three years to five years look like. Taking advantage of the growth in the marketplace and continue to invest where we need to invest.

But then also making sure that we are self-funding a lot of that and delevering at the same time, are really getting after costs, really getting after working capital, really getting after liquidity in a meaningful way.

And so, yes, I see opportunities there. We have got to bets some of those out over the next 90 days to 120 days. But I think we will have a whole lot more to say about that going into the new year. But I am encouraged by what I have seen of the opportunities I see out there so far.

Barry Cottle

Yeah. This is Barry. Just to add on — to add to what Mike said just real quick is this, as Mike said, I think, we set ourselves up to operate the business in a way that they can generate cash and manage through this environment.

So we don’t need to do the asset sales. We have obviously got an amazing strategic valuable asset in SciPlay. We have an amazingly strategic and valuable asset in our Digital business and we think that there’s strong strategic value in these where they have great futures in growth and send synergy within our businesses with brands, distribution channels and the player convergence that come along with it that makes Scientific Games actually uniquely a competitive advantage.

All that said, we always look at and explore ways to enhance value in the interests of all our shareholders, but it is more of looking at it as an opportunity as opposed — and staying out of it as opposed to a mean.

Barry Jonas

Really helpful. Thank you so much, guys.

Barry Cottle

Thanks, Barry.

Operator

The next question is from Brad Boyer with Stifel. Please go ahead.

Brad Boyer

Hey. Thanks for taking the questions guys and congrats on a solid quarter. First question for me, I appreciate all the color around the non-Gaming segments and all the momentum we are seeing there, but still kind of look at it and say Gaming still is your largest segment? And I was hoping you could provide a little additional color, Barry. You touched on a little bit some other answers, but just a little additional color around, what you are doing today to ensure that you maintain your position in the Gaming segment and in the Gaming market in these unusual times. Any additional color you could provide around that would be helpful?

Barry Cottle

Yeah. I mean, absolutely. I think first, I would put it in two buckets. One is ensuring that we have the right cost structure and efficiency in the organization to compete not just in COVID but when we come out of it, so that as the market starts to recover, we can invest in the right things.

And Matt and his team actually walked in the door, right, when COVID happened and things and plans that they had thought, had mapped out that they wanted to do accelerated quite frankly in COVID and it’s an opportunity for us to make this division as efficient as possible so that we could again invest in the products and services we believe we will win and I think they have done that.

And so the second piece is obviously winning the greater share of the wallet. And so the things that they have done are going after great products, right? So, in the unit sales space we launched two value-engineered cabinets that just recently in the marketplace with the Matrix and 5 Reel Mechanical.

We lined them up with really strong classic titles, new versions of classic titles. We also developed the commercial incentives around them and a commercial strategy with our operators to partner and be flexible in a way that we can potentially take share as their CapEx starts to come to fruition.

On the game ops side, very similarly, we took our top performing franchises like Dancing Drums, et cetera, improve the game performance. We — we have launched them with another — we are launching them with a new set of platform-agnostic cabinets as well some new coming to market.

Again with certain segment pricing and things to go after the market and attack it in the most strategic spaces, so a streamlined product roadmap with higher quality product with really strong commercial execution and operational efficiency.

And then we look at the market and said, okay, what does COVID present that we believe will occur during COVID and after. And that brought us to things like the electronic table games market, which we mentioned before, which is a really strong product line that we have put a lot of emphasis in in getting to market. We already have a significant share in the space but we are seeing more demand than we have ever seen.

And then the systems products that I mentioned before in terms of accommodating COVID, cashless, card-less. And so creating products that we believe the market needs and then just streamlining our products with higher quality games and driving operational efficiency in the organization.

Matt and his team has come in and done a stellar job of going after that in a challenging time and I think that sets us up for profitable growth now and going into the future where we are going to take market share.

Brad Boyer

Okay. That’s helpful. And then my second question is in light of some of the recent combination activity in the Sports bidding world from a technology perspective. I think there’s been this narrative out in the marketplace that more B2C operators are ultimately going to want to own their platforms outright. Could you just provide any perspective on that in this public forum from your perspective and just any conversations you are having with clients, what have you? Is that train of thought from your perspective misguided, just any color you can provide on that would be helpful?

Barry Cottle

Look, I would say, I shouldn’t say the word misguided, but I don’t think that captures what exactly is going on in the marketplace today. We see it both ways, and in fact, if you look at historically in the U.K. market, what you will find is the opposite happened, right?

So, majority of the players in the U.K. market at some point in time made attempts to run their own platform and then realized that they would rather have a robust platform that’s scalable and customizable and use that as a competitive advantage and focus on, what I would call, kind of a more customizable consumer — close to consumer type of technologies and capabilities.

And so, I would say, we are seeing a mix of that in the United States as much of some folks trying or going down that path, we are seeing also a counter to that of people walking away from their platforms and integrating ours and so, I think, you are seeing the balanced approach. I do think that the growth of the market will ultimately be supplier driven as opposed to B2C owned.

And the other thing that we are doing is very similar to what we did in the iGaming space is providing value-added services on top of the platform itself, right? And so, we are in a very similar way that we have the OGS platform, we just opened market which basically plugs in the best of best-in-class third-party Sports betting products and tools into our platform.

The one integration, we got everything and we were continuing to go up the value chain with Don Best and others to provide value-added services that are unique to the platform that we provide. So it’s out there, so I don’t, with — again, wouldn’t use it and misguide it, but it’s not a clear trend, it’s actually more of a balance than and the broader longer term trend we have actually seen go the other way.

Brad Boyer

Perfect. Thanks for the very thorough answers, guys. Appreciate it.

Barry Cottle

Thanks, Brad.

Operator

The next question is from Chad Beynon with Macquarie. Please go ahead.

Chad Beynon

Hi. Good afternoon. Thanks for taking my question. It might be too early to ask this, but since you have certainly made greater strides in the quarter than I think most of us thought. Do you have any medium-term leverage goals, I know before that was something you were really focused on and given that you are kind of running through budgets, are you willing to share maybe what 2021 or 2022 leverage goal could be?

Mike Eklund

Yeah. Chad, this is Mike and I will let Trent up in here too. I think you kind of hit it there. It’s a little too early to say. The reality is Q2, Q3 has been around making sure we are positioned to deal with whatever happens in the marketplace around us, right?

Let’s get the maturities moved out. Let’s get liquidity topped up. Let’s get after cost. Let’s get after cash. Let’s make sure that we are — we have got the financial well-being and health of the firm firmly in place and we do right now. We feel good about that.

We are kind of in a wait-and-see like the rest of the market now as to where this thing is going to go. Is it going to continue to move forward? Is it going to retrench to some of the questions that were asked?

As we said, we have got pretty good encouraging signs in the marketplace that things are inching forward and we are going to prepare for that, but we have kind of held off on any long-term goals right now until we just have a little better line of sight what’s going to happen in Q3.

So as that firms up and we get into our planning for 2021 and we have got a better idea of where things go. We will get a little bit more declarative on that front. But, obviously, to Barry’s point, we got Digital growing. We have got cash flow improving. We have got costs coming down. We have got Lottery holding, it’s on. We have got a lot of good momentum.

As all of those things happen they generate cash, they help us with that equation that you are referring to. So it’s clearly in our line of sight. It’s a top priority. There’s no scenario where it’s not going to be my top priority in the firm but it’s a little too early to say right now.

Chad Beynon

Okay. It makes sense. And then regarding SciPlay, the metrics, particularly ARPU was very strong and I am sure you guys will get into this on the SciPlay call. It’s certainly kind of confirms that your monetization teams are doing better and you acquired Come2Play, which I think is an interesting acquisition and it gets you into the casual game space that doesn’t have as strong monetization. Small acquisition, but given that you guys are doing so well. Do you think casual games could become a bigger opportunity for you given everything that you have learned in your successes in terms of monetizing games and given that the pool of games and customers is significantly larger than the current pool for casual game — for casual casino? Thanks.

Barry Cottle

Yeah. Absolutely. I think the playbook here is to look for companies that we believe in the game and the game themes. These casual puzzle, card, board, like-skilled mechanic with very simple gameplay, very similar to a slot. We plug it into our monetization machine. We create meta games on top. We create monetization loops. We create social loops. We improve their UA.

It’s the exact same playbook we use for bingo which tripled that business and the goal is to come in and find people who really understand and know a core mechanic and do it really well. In this case, the solitaire game, which we are really — we really like and then we layer on our knowledge and expertise with them to go — to build that category.

And you are exactly right, the casual game space is bigger. It tends to be less monetized but that’s where our expertise is, is taking these simple loop games and figuring — and building the meta game around them in order to get that monetization. And so you are exactly right and we are very excited about it and the team that we have got there.

Trent Kruse

And Chad, this is Trent. I would just simply add to that point on monetization. They do run some ad-based business and so this is going to give us a chance to look at and learn in that space as well which could create another avenue for growth for us down the road.

Chad Beynon

Thanks. Appreciate it. Nice results, guys.

Barry Cottle

Thank you.

Mike Eklund

Thank you.

Operator

The next question is from Ryan Sigdahl with Craig-Hallum Capital Group. Please go ahead.

Ryan Sigdahl

Thanks, guys. Good afternoon and congrats on the good results in the challenging environment here.

Barry Cottle

Thank you, Ryan.

Mike Eklund

Thank you.

Ryan Sigdahl

Just want to dig in a little bit more to say on the new customer that’s coming. Is that a new Digital customer or is that an expansion with an existing operator and then is that a new online participant or you are displacing someone else that expire?

Barry Cottle

Yeah. Basically what we are seeing is when people were forced to work from home, they had to learn and adopt a new way to do the things that they love, right? And so we are seeing — I would say, it’s both, we are seeing new players coming to the space and getting comfortable with digital and mobile gameplay and I think that just expands the addressable market.

In addition to that, because that your phone is on you 24×7, we are also seeing frequency of play. It happened as well whereas if you have to get up and drive to a land base entity y to make at bet or to play a game, you — there’s a barrier or friction there. So we are seeing both. We are seeing frequency of play, frequency of spend and spend and then we are seeing new people come in that enter the market.

Trent Kruse

And Ryan, just to your point on our new deals in the future, it is both, it’s on the iGaming and Sports side, and as Barry alluded to earlier, multi-jurisdictional, so certainly some exciting things on the horizon.

Barry Cottle

Yeah.

Ryan Sigdahl

Yeah. Maybe just to be more clear, the new customer that’s coming for Digital that you talked about in your prepared remarks, is that an existing Digital customer that you are expanding with, or is that a brand new operator that you are adding?

Trent Kruse

Ryan. It’s Trent again. I — it is an addition, but we really can’t say anything more beyond that today, but we will have an announcement soon.

Ryan Sigdahl

Got it. Moving on, one more for me, so on the casino customers that have reopened, so partial capacity. What have you seen from their machines, which ones are they turning on? Is it their own machines or is it the premium leased? And then how are your machines and then how are your machines comparing versus competitors?

Barry Cottle

So I think most of them are balancing the space, and so, I would say, ultimately, it’s really balanced quite frankly. It’s what we are seeing in terms of the — what machines are getting turned on. I will say, a lot of — you are seeing a lot of obviously gravitation toward familiar big franchises, which plays well into our world, right, with the franchises that we have are well-known.

It’s kind of like when your restaurants all got turned off or shutdown and restaurants that came back up and everybody didn’t go to a brand new restaurant. You went to the restaurant that you loved and missed the most, right? And so, in a lot of ways the same thing happens here and the great news is we have got such great traditional plethora of franchises that are out there in the marketplace.

And as I mentioned earlier on, the — we are seeing significant coin-in on an active machine above and beyond what we would normally see and so the balance of that tells us that we are really doing well. We can’t point to competitively yet. There’s no reports out there that will — that would give me any credibility on that. But we are encouraged by the results of putting that one

Ryan Sigdahl

Thanks, guys. Good luck.

Barry Cottle

Thank you.

Operator

This concludes our question-and-answer session. I would like to turn the conference back over to Barry Cottle for any closing remarks.

Barry Cottle

Hi, all. Thanks for joining us today. We really appreciate your support and I am very pleased with the actions we have taken in the second quarter with the successful note offering and implementing cost saving measures, while continuing to operate effectively for our customers. The diversity of our businesses and being on the forefront and being on the forefront of Digital Gaming was critical to allow us to successfully navigate the worst of this environment. We have the right team coupled with the best products across both land based and mobile gaming to position us for the future profitable growth. Thank you very much.

Operator

The conference has now concluded. Thank you for attending today’s presentation. You may now disconnect.





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Atlassian Corporation’s (TEAM) Management on Q3 2020 Results – Earnings Call Transcript


Atlassian Corporation Plc (NASDAQ:TEAM) Q3 2020 Earnings Conference Call April 30, 2020 5:00 PM ET

Company Participants

Matt Sonefeldt – Head-Investor Relations

Mike Cannon-Brookes – Co-Founder and Co-Chief Executive Officer

Scott Farquhar – Co-Founder and Co-Chief Executive Officer

James Beer – Chief Financial Officer

Jay Simons – President

Conference Call Participants

Rishi Jaluria – D.A. Davidson

Michael Turrin – Wells Fargo

Ittai Kidron – Oppenheimer

Nikolay Beliov – Bank of America

Keith Weiss – Morgan Stanley

Heather Bellini – Goldman Sachs

Gregg Moskowitz – Mizuho

Luv Sodha – Jefferies

Keith Bachman – Bank of Montreal

Ari Terjanian – Cleveland Research

Steve Enders – KeyBanc

Derrick Wood – Cowen

Operator

Good afternoon. Thank you for joining Atlassian’s Earnings Conference call for the Third Quarter of Fiscal 2020. As a reminder, this conference call is being recorded and will be available for replay from the Investor Relations section of Atlassian’s website following this call.

I will now hand the conference over to Matt Sonefeldt, Atlassian’s Head of Investor Relations.

Matt Sonefeldt

Thank you. Good afternoon, and welcome to Atlassian’s third quarter of fiscal 2020 earnings conference call. Thank you for joining and supporting us. On the call today, we have Atlassian’s Co-Founders and Co-CEOs, Scott Farquhar and Mike Cannon-Brookes; our Chief Financial Officer, James Beer; and our President, Jay Simons.

Earlier today, we issued a press release and a shareholder letter with our financial results and commentary for our third quarter of fiscal 2020. These items were also posted on the Investor Relations section of Atlassian’s website. On our IR site, we also posted a supplemental presentation and data sheet. During the call, we’ll make brief opening remarks and then spend the remainder of time on Q&A.

Statements made on this call include forward-looking statements. Forward-looking statements involve known and unknown risks, uncertainties and other factors that may cause our actual results, performance or achievements to be materially different from any future results, performance or achievements expressed or implied by the forward-looking statements.

You should not rely upon forward-looking statements as predictions of future events. Forward-looking statements represent our management’s beliefs and assumptions only as of the date such statements are made. We disclaim any obligation to update or revise them should they change or cease to be updated. Further information on these and other factors that could affect the company’s financial results are included in filings we make with the Securities and Exchange Commission from time to time, including the section titled Risk Factors in our most recent 20-F and quarterly report on Form 6-K.

In addition, during today’s call, we will discuss non-IFRS financial measures. These non-IFRS financial measures are in addition to, not as substitute for or superior to measures of financial performance prepared in accordance with IFRS. There are a number of limitations related to the use of these non-IFRS financial measures versus their nearest IFRS equivalents, and they may be different from non-IFRS and non-GAAP measures used by other companies. A reconciliation between IFRS and non-IFRS financial measures is available in our earnings release, our shareholder letter and in our updated investor data sheet on our IR website. During Q&A, please ask your full question upfront so that we can more easily move through to the next speaker. Also, please be patient if we encounter any disruptions or challenges and logistics, given we are individually dialing in from our homes across the world.

With that I’ll turn the call over to Mike for opening remarks.

Mike Cannon-Brookes

Thanks everyone for joining today and for your continued support. We want to start by saying we hope you and your loved ones are safe and healthy. We are in unprecedented times. It’s more important than ever that we embraced our mission to unleash the potential of every team and support our staffs, customers and communities. As you’ve hopefully read in our shareholder letter, we are confronting this crisis head on. Rapid economic change shapes up industry leader boards, and we will continue to position Atlassian to drive long-term growth in the coming quarters and years.

We will leverage our resilient culture and the strength of our business model to take share in the massive markets that we serve. Over nearly two decades, we’ve learned to navigate and adapt to macro change. While we plan to play offerings in this cycle, we also acknowledge that the macro economy presents some serious headwinds. During Q3, our performance was unscathed. We posted strong results with 33% year-over-year revenue growth, 6,200 net new customer additions and solid profitability. At the same time, the reality of serving over 170,000 customers means we have exposure to the small business economy and COVID-impacted industries. We have provided much more detail and many other updates in our shareholder letter that was issued earlier today. We are committed to emerging stronger from this storm, and our culture will help us set our direction.

Before we move to questions, we want to thank our employees for demonstrating incredible resilience and adaptability in becoming a fully remote TEAM under pressure. It has been difficult, and our hard work has never been more important as we support millions of teams across the world.

With that, I’ll pass the call to the operator for Q&A.

Question-and-Answer Session

Operator

Your first question – thank you for calling. [Operator Instructions] Your first question from the line of Michael Turrin with Wells Fargo. Michael, your line is open.

Mike Cannon-Brookes

Everyone’s speechless with the results we have delivered this quarter. Great. Maybe we’ll come back for Michael.

Operator

Your next question from the line of Arjun Bhatia with William Blair. Mr. Bhatia, your line is open. Mr. Bhatia? And your next question from the line of Arjun Bhatia. And your next question from the line of Jack Andrews.

Jack Andrews

Hi, good afternoon. Can you hear me okay?

Mike Cannon-Brookes

Just, fine.

Jack Andrews

Great, thank you. Thank you for taking the question and glad to hear everyone is doing well in this environment. I want to ask something about the – something in your shareholder letter. You mentioned that I think 23% of your attendees from your recent Remote Summit came from business teams, which was essentially double from 2019. I was wondering if you could just talk about what is really accounting for that increase there, whether there’s something that’s happening organically or whether you’ve pivoted your marketing message. And then the second question would just be any early feedback on the new cloud enterprise product. Thank you.

Matt Sonefeldt

Hi, I’ll take the first one. I think it’s just an indication of the continued interest and how broad our products can be deployed and a diverse set of audiences they serve. I mean, Remote Summit lowered the barrier to entry to Summit. So it could be that there’s a lot of interest from a line of business participants in our product and users of our product that may not want to travel all the way to San Francisco for an event, but we made it far easier for them to join an event, meet – and I think that’s something that we’ll continue to explore going forward. And I think Mike will take the enterprise cloud question.

Mike Cannon-Brookes

Sure, Matt. Look, cloud enterprise to those who don’t know was our latest addition of our cloud products that was launched at Summit a few weeks ago. It’s certainly been one of our most important and challenging initiatives in R&D over the last few years. It does give us a full ladder now of cloud additions to meet any customer size. If you count three standard premium in our enterprise with, of course, access for identity and content management across the set, that enterprise addition helps us meet the needs of the, obviously, the largest and most complex enterprises that want unlimited scalability, data residency, the complex security needs to come with that, et cetera.

Those are obviously extremely hard to build to meet those requirements. And those requirements are incredibly prudent for the largest enterprises in the world as they move to the cloud. We obviously had a very good reception to that announcement of the early access program at Summit. We don’t expect it to be a material contributor in FY 2020 or even in FY 2021 as we get those larger customers ramp up. But obviously, in the long-term, it’s an incredibly important initiative. In terms of existing feedback from those large enterprises that have joined the early access program, it’s been very good. Obviously, we spent a lot of time with them before that, making sure that we were building what it was that they wanted, and it was just a validation that we’re on the right track with that addition.

Operator

And your next question comes from the line of Michael Turits with Raymond James.

Michael Turits

Hi, good afternoon everybody. You guided slightly below the street for next quarter and commented that COVID would impact fourth quarter more than the current quarter, if this is a good quarter. I was wondering if you could speak a little bit more specifically about where COVID and the emerging recession will specifically impact the business.

You mentioned SMB, for example, you mentioned COVID-impacted industry. So I was wondering if you could talk a little bit more about that calculation. And my follow-up question would be what you think the impact of all of this will be on the pace of software development projects being rolled out, and of developer hiring and how that might impact you guys in the next 12 months?

Scott Farquhar

Michael, it’s Scott here. I’ll talk to the broader theme, and James can talk about the fiscal impact. As you well know, we have 171,000 customers around the world, everything from Fortune 10 to most of the Fortune 500 and tens of thousands, we talk about the Fortune 500,000 being our market that we do. We have no strategic customer concentration. No one customer makes up more than 1% of our revenue. So there’s not sort of a specific area there. But of course, as you expect from such a broad market that we’re exposed in the same way that you would be kind of across all the different geographies and industries that we’re in.

I do think there is a sort of short-term benefit of people using our products in terms of the work from home aspect they’re using collaboration tools more in the short term. I think the long term, the aspect is that people are going to work remotely more than they have to date. That’s going to require more collaboration tools, whether that is collaborating on work product in Confluence, whether that is managing more workflow in Jira versus talking to the person next term at a desk.

So we see that there’s some benefits of that over the long term. In terms of pace of software development and hiring, I think we’re 6 weeks into this, it would be too hard to talk about that as a broad industry trend. We haven’t seen anything that makes us significantly change what we believe internally about that. James, do you want to talk through any test specific financial impacts there?

James Beer

Sure, thanks, Scott. Yes, as we said, pleased that really a negligible impact from COVID-related factors in Q3. We have seen some impact in April. And in terms of the fact that we serve such a highly diverse set of customers really across all business sizes, geographies and industries, is really one of our major business model advantages. And the reality of that is that when you’re serving that mainly customers, we are going to have exposure to the small business economy and to those particular sectors that have been particularly impacted by COVID.

Now of course, this is reflected in the guide. And yes I would particularly emphasize that, that guide underpins some very beneficial aspects of our revenue model. Recall that over 90% of our revenue comes from existing customers. And indeed, over 85% of our revenue is recurring in nature. So overall, we’re pleased with how the business performed in Q3. We feel like the guide reflects the impact of the coming quarter.

Michael Turits

Okay, thanks guys.

Operator

And your next question from the line of Arjun Bhatia with William Blair.

Arjun Bhatia

Hey, guys. Thanks for taking my question. You mentioned in the shareholder letter that cloud migrations were up 60% this year. How do you think the pace of this migration plays out over the rest of the year, given we’re in a bit more of an uncertain and maybe IT departments are a little busier just trying to keep the lights on. And sort of related to that, we’d just like to hear some early feedback that you’re hearing from the cloud enterprise program that you launched.

Mike Cannon-Brookes

Sure, Matt [ph] I can certainly crack that. Look, in terms of migrations, let me start there. We continue to monitor, obviously, how that will be affected. I wouldn’t say we’ve seen much of an effect other than the normal growth in migration so far. It’s probably worth noting – the larger you are as a company, it’s obviously a large IT transformation project. But once you’ve moved to the cloud, you have reduced impact in terms of the operational load on your own team.

Effectively, Atlassian takes care of a lot of things and you would have taken care of yourself. So depending on your increased workload in a COVID environment, it can actually reduce your workload quite significantly as an IT department to let us handle a lot of the bits and pieces. And that, obviously, as you get smaller down the chain, that can be more pronounced if you are a 500 user customer, or a 100 user customer. So we remain vigilant as to how that will affect the growth we’ve seen in migrations, which has been really good so far.

It’s worth noting that’s been increased by the release of the Jira Cloud Migration Assistant, which is a tool we shipped during the last quarter that allows Jira users, predominantly Jira Software, Jira Service Desk to pick up and move their data to the cloud much more easily. And so it helps you through a lot of the more complex transition work. And that’s obviously increased both the pace and the accuracy of those migrations which has been really good.

From a cloud enterprise perspective, I don’t have a lot to add to what I said before, obviously the early reaction to the ERP from customers who have joined it has been very good. Largely along the lines of that this is the addition we’re looking for. This checks a lot of the boxes that we made, from the highest and most demanding customers with good scale, performance and security requirements. We’ll move into assessment mode and have a look at this. And we are working together with those early access program customers to make sure that cloud enterprise continues to evolve to meet their needs.

Arjun Bhatia

Perfect, thank you. And James as a quick follow-up if I may…

Jay Simons

Sorry, I lost you there.

Arjun Bhatia

Can you hear me now?

Jay Simons

Yes.

Arjun Bhatia

Okay. Sorry about that. Yes, I was just asking about how you’re thinking about price increases this year relative to what you’ve planned and whether those plans have changed at all given the increased uncertainty.

Jay Simons

Well as you know we have a very thoughtful and rigorous process to considering pricing moves, and we’ve been doing that for some years now. When you think about what we’ve done in years past, it’s in a balance between lowering prices and in some instances raising prices. And to layer on top of that as well, it’s important to think about the additions, the strategy that we’ve been pursuing in recent times. So now with the roll-outs fully of the free additions of Jira Software, confluence and Jira Service Desk, that compliments the standard additions, the premium additions and as Mike was speaking of earlier now, beginning to roll out the enterprise additions as well.

So, the additions represent another way in which we can be paid for the incremental value that we are offering our particular customer. And our customers are able to align their needs with the right addition. And so that will be an ongoing part of our strategy in years ahead.

And then in terms of a specific price, we’ll always obviously be thinking through all of the different relevant factors, both competitively and relevant to our customers. So we’ll always be looking to find the right balance between being compensated for value that we offer to our customers while being cognizant of doing the right thing for our customer set as well. So we’ll keep having that perspective around pricing, and we’ll update you in the months ahead.

Arjun Bhatia

Perfect, thank you.

Operator

Your next question is from the line of Rishi Jaluria with D.A. Davidson.

Rishi Jaluria

Alright, thanks for that. That’s a new way to pronounce my name. This is Rishi Jaluria from Davidson. Thanks for taking my questions guys. So two, first I wanted to appreciate the commentary that more resilient model because 90% of our revenue comes from existing customers. I just want to drill down a little bit more into that. If we were to kind of take a snapshot of any given year how do we think directionally of new business with a new year, how much comes from existing versus new. And following up on that, if you were to think about your penetration within your existing customer base, I’m sure you’re pretty under penetrated right now. But directionally, what do you think that opportunity just within the existing customer set looks like? And then I’ve got a follow-up.

Mike Cannon-Brookes

Well certainly, we’ve noted that 90% of our activity of our revenue each quarter comes from our current customers. So, we tend to add a lot of new customers each quarter, Q3 was another example of a very nice number, additional customers. But those tend to represent a relatively small proportion of the dollars that we generate each quarter. So it’s very much the bulk of the dollars coming from our Expand Motion. And of course, we have a variety of ways in which to expand across products, across additions that I was just referring to in the earlier question, in terms of expanding across a broader part of that customer, serving more of the groups at that customer, and so forth.

And so we routinely talk about the fact that we believe we’re early in our work to address these very large markets that we serve. So we continue to be very focused on the long term opportunity and very confident about our ability to address that real opportunity.

Rishi Jaluria

Okay, great. That’s helpful. And then just as a follow-up, you did talk a little bit about with the guidance, the SMB side of the equation. But I wanted to think about industry exposure, right? Obviously you’re very well diversified across industries, but if you were to think about just your exposure again directionally to some of the more impacted industries like travel, hospitality, retail, energy. Just wondering if you can give us a sense for how big that exposure looks. Thanks.

James Beer

Sure. Again, we really cover all industries, all sizes of companies and all geographies. That’s one of our terrific business model strengths. And so, yes, we obviously serve some of the companies, but like in the travel sector that would be particularly hard hit in the last several weeks. But really the focus of where we’ve seen an impact is on the smaller sized company end of the spectrum. In fact, it was notable to me how one of the larger FRS deals of March, it was with an important travel services company. The deal took a few more days to close and actually rolled into the early part of April. But at the end of the day I was very comfortable with the terms that we settled upon. And the customer was very appreciative of the fact that we have worked with them to help them through that particularly difficult time.

On the smaller end of the spectrum, obviously that’s where we have more of our cloud customers, recall, that we’ve spoken now or a couple of quarters ago about the fact that we have more than 125,000 cloud customers out of our total of, most recent figure today reported 171,000. So we do skew in our cloud business to a full size of organization.

Taking a step back from that more broadly, I’d say we’re holding steady across the enterprise and large enterprise portions of our business. And on the cloud side, going back there for one last thought I’ve been pleased that while they say there are some customers that who are seeing an impact. I’ve been very pleased by the number of new cloud customers who have been coming to us both in the month of March and thus far in April. In fact, March was the strongest month for Q3 for the addition of new cloud customers. And of course that’s lining up with a month in which we had fully rolled out our three offerings as well. So, really we’re quite encouraged by the developments there in terms of continuing to attract new cloud customers.

Rishi Jaluria

Okay. That’s really helpful. Thank you.

Operator

Next question is from the line of Michael Turrin with Wells Fargo.

Michael Turrin

Hey there. Thanks, good afternoon. I was hoping to hear more around the decision to play offense here in this backdrop. It sounded pretty clear in the letter that you are planning to keep pace in terms of hiring and play offence here in the coming months. Can you just spend a little more time in terms of what that means from your perspective? Are there any specific areas you see yourself maybe pushing even a bit faster behind? And are any of those impacts showing up here in the free cash flow guide, we saw somewhat of a reduction here as well? Thank you.

Mike Cannon-Brookes

Sure let me take that from my side and Scott or James can jump in. As I think we felt it was really important in line with our values. So one of our company values is open company, no [indiscernible]. We wanted to be very clear with investors and partners about how we were approaching the current environment, which is obviously, unusual, it’s not business as usual at the moment. And I think as a company, you have to choose a long-term strategic path with very clear thought as to why one is choosing that path because this is going to play out over many, many quarters.

When we sit down and think about it like – strengths, beside the fact that we are in very large markets. We have a capability to actually gain share through these quarters with turbulence. However, they come at us, and we remain very adaptable and thoughtful about them. Our culture is extremely strong and adaptable. Obviously our go-to-market models, you’re presumably well familiar with, suits the flexibility of these type of environments as we don’t have to get on a lot of plains to sell stuff. We have product innovation and we have an extremely strong, obviously, financial position in terms of generating free cash flow as well as obviously, the cash we have on the balance sheet in the business and the stability of our revenue streams.

So I think when you put all that together, it’s – hopefully shows some of the background why we feel confident to take that strategy as we sell into the coming quarters and years about how we are planning to approach that and why we are choosing to communicate that. Scott, maybe you want to go into a little bit about the actual effects of what that means? We listed a couple in the letter.

Scott Farquhar

Yes, I will touch on them again. The types of things that we’ve done in the past. And Mike and I would hopefully consider ourselves still fairly young in the business and we we’ve been running last year and since I started in the dot-com crash in 2001. And we remember the global financial crisis in 2008 and 2009, pretty clearly. And some of the things we did back then and what we’re doing again now is picking up great key hires and talent that’s available and that we could – maybe wouldn’t be on the market otherwise. So that’s doing well.

Customer acquisition, we’ve – 12 years ago now, we released starter licenses and reduced our price from $1,000 down to $10 for many of our products. A few months ago, we launched free and those in free effectively to that $10 down to zero to aggressively try to acquire customers. And also, I think that increased product innovation, continuing the R&D investments that we are known for and yield great value for our customers. And if there’s any opportunistic M&A that turns up we’re not necessarily going hunting for it, but like there’s often opportunities in this particular market environment where you can pick up things that are very attractive that otherwise, again wouldn’t be available.

So, all those things that we’re considering and we’re discussing in a weekly basis in terms of how to be more, I guess, opportunistic in these times. James can talk to how that flows into free cash flow guidance.

James Beer

Yes on the guide I would just observe obviously we’ve laid out our revenue guide, the free cash flow guides directionally consistent with that. But then also from a working capital perspective, I don’t know if it’s fair to say that we working with a small subset of our customers who requested help in these extremely challenging macroeconomic times. Now this is a relatively small proportion of our total customer base, less than half of the percent, but we feel as though that’s the right thing to do. And it’s an illustration gain of the long-term orientation that Scott and Mike have been talking about on this call already, just another illustration of that mindset that will work out well for those companies and well for us.

Michael Turrin

That’s a great color for me James, much appreciated. Thank you.

Operator

Your next question come the line of Ittai Kidron with Oppenheimer.

Ittai Kidron

Thanks. Good numbers guys. I guess I wanted to follow-up on a couple of things. First of all, with respect to the free cloud additions, great to see that out. Maybe you can tell us on how many downloads you already have. Or any statistics that you can have there that helps us understand uptake, interest, level of interest or conversion rate, anything on that fund. And I know it’s early, but some color would – would be appreciated.

And then for James on the perpetual license revenue decline, clearly, I’m assuming this is demand related, but maybe you can help me think about that in the context of how much of that was perhaps customers shifting to cloud versus true reflection of softer business activity? And should I assume that that also is the main area where with respect to your guidance, that’s where we see most of the weakness near term.

Mike Cannon-Brookes

Yes. Ittai, I’m Mike I can certainly take the top part of that question. It could be something else as a tricky name. So that’s [indiscernible]. Look, it’s still very early, the results are in fact incredibly encouraging. For history, we started rolling out our free editions back in October in a very limited sense as we told you in the shareholder letter. So sort of looking at 5% and 10% of traffic and seeing what the effects were, as we are always very thoughtful with the impact of changes we made to pricing and try to consider the long-term benefit to that. We solely expanded that.

Obviously, with COVID in the current crisis, we decided to accelerate that somewhat and rolled it out fully in March, which is now available for Jira Software, Jira Service Desk and Confluence. Obviously, that’s alongside Trello and Bitbucket and other products that already had three editions, and that’s a large part of their model already in the cloud.

That have been we didn’t include any closing so far. We can say up to March we had 125% uplift in valuations, which is obviously actually a little bit ahead of where we expected, but is looking really positive for that perspective. I would reiterate, it is extremely early. We did that, I think it’s less than four weeks ago now, a little over four weeks ago. So we’d expect a pop-up off of that. And then it settled down to a number, but it’s extremely in a good spot in terms of where we think it should be. And we had seen limited evidence so far, I would say, but certainly some evidence that is helping us get into even more markets and rich users we would not otherwise have been able to get to, which is our goal of heading towards the Fortune 500,000, so it’s a great step on that particular journey.

Just reiterating the long-term rotation, and this is a great step on that journey. James, I don’t know if you want to take any financial impacts of that?

James Beer

Sure. Well I’ll speak to the license part of the question in particular. First of all, recall that in Q2, so 90 days ago we reported quite a significant pull-forward effect that was driven by the price increases that we had announced previously. So, what we saw in part in Q3 was the effect of having activity that otherwise would have occurred in Q3 actually get pulled forward into Q2.

Now, the second point that’s really important though is that – and as we’ve been talking about this theme now for a number of quarters, is that we’re very much orienting our business towards continuing to grow to subscription revenue business, the cloud business and the data center business. So you saw subscription revenue growth of 67% year-over-year, very much substantial, the primary driver of the revenue line for the company now. And I would expect that that will continue.

And commensurately, you’ll continue to see license moderating over time. In fact, recall that the license line now is a relatively small one. It’s a small component of our overall revenue structure. So this past quarter, the absolute dollar figure is $21 million. So I would continue to expect that we’ll see less license activity over time and more subscription revenue growth.

Ittai Kidron

Thank you, guys.

James Beer

Thank you.

Operator

And your next question is from the line of Nikolay Beliov from Bank of America.

Nikolay Beliov

Hi. This is Nikolay Beliov from Bank of America. Thanks for taking my question. I want to double-click on the 60% increase in migrations from server to cloud. Just wondering how do you measure that? Is that based on users, customers, revenue, et cetera? As you saw that uptick this fiscal year, what strength did you see under the covers in terms of customer sizes moving from server to cloud? Did you guys take advantage in more upsell?

And lastly, what have been the partner feedback on migration tools that got launched a couple of months back, as customers move from manual migration to more automated migration, are we talking about significant decrease in the time of migration maybe from months or weeks? Just whatever you’re seeing would love to get to hear from you guys. Thanks so much.

James Beer

So Nikolay, in terms of – I have some of my colleagues will jump in as well. But in terms of your first part of the question, the migration statistics that we mentioned for our service cloud activity, they’re driven off user count. And in terms of our customer size that is migrating, what we are seeing is that, step-by-step, as we continue to add more capability to our cloud products, as we continue to rollout and increase the capability of the different additions that we’ve been talking about on this call, then we’re seeing more larger companies making that move. And I think we’ll continue to see this trend play out that way over the coming years. Mike spoke earlier to the rollout of enterprise additions. So now we’re in a position where we can address the needs of any customer size.

And I was going to refer to the helpfulness of those migration tools before you added it to your question. I think that has been an important aspect of us continuing down this pathway of making it easier for our customers of all sizes to migrate their path. Jay, over to you.

Jay Simons

Yes. I’ll just jump on, Nikolay, with the back part of that question. I mean, the migration tools are built both for customers that can migrate without partner assistance, also for partners to basically enable a better, more reliable migration. And remember, like in the partner case, there’s a bunch of work that we’re going to do around the migration. That doesn’t involve just moving data from server to cloud. In many cases, they want to reconsider their workflow. They want to reconsider how their projects are structured.

So we’ve taken the work out of basically moving data from point A to point B. But in point B, they have an opportunity to rethink what they really want to do or how they want to change the product. In many cases, the server customers have been using the server product for five or six years and so there may be some classification that they want to partner to help them move past. And I think we’re going to measure that just in terms of velocity over time, like constantly, both with the partner and with the customer directly, we want to make sure that moving is ever, ever easier.

Nikolay Beliov

Got it. And just one clarification question, if I might. James, you mentioned, I believe that you saw some COVID impact in the month of April. Can you please give us some color where in the business you saw that exactly? Thanks so much. That’s it from me.

James Beer

Yes, Nikolay, nothing really to add to our previous answers, the April impacts really in the SMB space, with more of an orientation of SMBs to our cloud products. And then obviously, the most heavily impacted industries in terms of the macro impact from COVID, seeing some factor there, but absent that, nothing noticeable to report across industries or across geographies.

Nikolay Beliov

Thanks so much.

Operator

And your next question is from the line of Keith Weiss with Morgan Stanley.

Keith Weiss

Excellent. Thank you guys for taking my question. Congrats on a very nice quarter. I wanted to follow-up on – I think this is a question that Mike Turits was trying to ask, maybe I’d be a little bit more direct about it. One of the things investors are trying to understand is like which solutions do customers find most strategic and most mission-critical and where you’re most likely to sustain demand even through difficult times and which ones are perhaps less – or deemed less mission-critical.

And I think the question we’re trying to ask is like, if we look across the solution portfolio, is there parts of the portfolio that people find to be more mission critical? Do you expect the demand to sustain better in? Like if we think about Jira Software less mission-critical and Jira Service Desk more? Or is there any way you could kind of help us out in terms of how the customers are thinking about the mission criticality of the suite, number one?

And number two for James, on the – I know it’s a very small percentage of customers, but the customers that are asking for help, is the form of the help that you guys are willing to give, is that just on payment terms and the like? Or are you guys actually kind of modifying existing contracts?

Scott Farquhar

Keith, Scott here. I’ll answer the first bit about sort of where our products are most mission critical. Now what we’ve found is that our products because they are workflow products that are embedded in our customers’ workflows in almost all the cases of what we do, whether it’s Trello or it’s Confluence or it’s Bitbucket or it’s Confluence for doing collaboration or it’s just service sets of serving your customers, your internal help desk, like all those things are baked into our customers’ workflows. And so we don’t really see them as a discretionary expense that gets turned off when you want to save money, like it’s a key to people being productive. And I think we have an added benefit that we’re relatively compared to our peers or competitors, we will be well cost to provide that outcome.

And so we – in 2008, we saw some benefit to us because people switch to a low-cost provider to provide those things where maybe they had a legacy provider and they wanted to move. Now – so that’s the way I think about it. It’s not an area where I’d say we’re particularly strong or weak there. Obviously, our customer base, the more embedded we are in our customers, the stickier we are, and so to the extent that more – to be able to customize our products more, which we’d say probably a medium or larger-sized customers have customized our products more. And where people use our third-party marketplace so if two companies look alike, I’d say the ones that have customized it more and have used more third parties, we know are stickier in the numbers.

James, do you want to talk to the next part?

James Beer

Yes, sure. The bulk of where we’re working with our customers are really around payment terms. And I’d note that those are changes to our arrangements that are temporary in nature, and that’s quite clear in our dialogue with those customers.

Keith Weiss

Excellent. Super helpful. Thank you, guys.

Operator

And your next question is from the line of Heather Bellini with Goldman Sachs.

Heather Bellini

Great. Thank you so much. Just had a couple of follow-ups. And thank you, I know the shareholder letter was longer this quarter, but it was very helpful. My two questions relate to a little bit what other people have been asking. Just looking at what you said about April, are you assuming that spending levels from those affected companies and industries, stay the same throughout the quarter? Or in your assumptions, are you expecting business to actually get better for those affected companies and industries in May and June?

And then my follow-up is just, again, you also highlighted 90% of your revenue comes from existing customers. From the industries that aren’t impacted, what assumptions are you making about net expansions, if you will, versus prior periods for June? Thank you.

James Beer

Okay. Heather, I’ll take that one. So in terms of the guidance that we’ve offered, a few thoughts. First of all, I’d say that the philosophy that we brought to setting the guidance in terms of setting the range, placing the range is quite consistent with what we have done historically. We have laid out a broader revenue range. Clearly, with this macroeconomic uncertainty, there is a greater potential variability in our results. And it’s certainly challenging to accurately estimate the current environment’s impact across such a large customer base.

So we have looked carefully at our experience in April and considered that and our various leading indicators are top of funnel type indicators and assumed that, that sort of situation plays out across the balance of the quarter. So hopefully, that’s helpful to that part of the question.

In terms of around the 90% or so of our revenue that comes from our existing customers. I wouldn’t add anything other than, obviously, we factor in what we’ve been seeing in the last few weeks. And again, think specifically about the relevant forward-looking indicators for that type of element of the overall revenue structure.

Heather Bellini

Great. Thank you, James.

Operator

And your next question is from the line of Gregg Moskowitz with Mizuho.

Gregg Moskowitz

Okay. Thanks. Gregg Moskowitz from Mizuho. Hi, guys. I guess my first question, in the shareholder letter, you mentioned that you have over 150,000 organizations on starter licenses or subscriptions, and clearly, it’s a very large number. However, there were over 175,000 starter accounts a year ago. And just given your very strong top of funnel, I’m wondering why that has declined. In other words, have you converted a lot of these to paid accounts? Or are there a bunch of them that have just gone away for one reason or another? Hello?

Mike Cannon-Brookes

Hi, Gregg. I think, Jay, can you take that one?

Jay Simons

Yes. Hey, Gregg. So I think the macro trend is just the shift to cloud. Remember, like the starter license largely talks about the server end user license for $10. And increasingly, the more attractive value proposition even at the pre-free price was to move to cloud, and that was like the macro trend, people aren’t going to install a piece of software, if you can get it for effectively the equivalent price run in the cloud. So that’s been some pressure. And then free is a far more attractive place to start on any Atlassian product. And so that’s sort of the – I think the macro effect here on the server starter license.

Gregg Moskowitz

Right. Okay. Thanks, Jay. And then just as a follow-up, curious about what kind of demand you saw in the quarter for data center subscription as well as your cloud premium SKU? Thanks.

Jay Simons

Good. We were pleased with both. I think James mentioned this. But largely the enterprise segment, both just in terms of how we performed in the quarter and then the overall pipeline and traction, we saw both through the quarter and headed into this one with positive, both across data center, both directly and then in with our indirect global channel, and from standard to premium as upgrade pattern in cloud.

Gregg Moskowitz

Perfect. Thanks.

Operator

And your next question is from the line of Brent Thill with Jefferies.

Luv Sodha

Hi, this is Luv Sodha on for Brent Thill. Thank you again for squeezing me in. First of all, congrats to Jay given it’s his last quarter. And I wanted to ask maybe a couple of questions. One was now with the release of the Atlassian Cloud Enterprise, could you maybe talk about the investment in Enterprise Advocates? I know you guys have a viral go-to-market motion. But the Enterprise Advocates have been helping in terms of phishing Atlassian as a solution set. So what about the investment in that team going forward?

And then the second one, on the M&A front, I know you guys mentioned that you would be more offensive there. Sort of anything in your portfolio that’s lacking right now? Or how would you think about the strategy going forward? Thank you.

Jay Simons

Yes, I will take the first one. So we’ll continue to invest in Enterprise Advocates as we have to support the data center upgrade motion in server, both the migration motion from server to enterprise cloud and the upgrade motion from standard cloud to enterprise cloud is really similar. And so I think we’ll continue to expand that team to serve the opportunity that enterprise cloud presents, both for existing server customers and moving in for big enterprise customers that are growing.

Remember that we get a lot of leverage in the Enterprise Advocates group, both from our indirect channel that we – that is pretty large and deeply connected to our products and our customers in the market, and we work hand-in-hand with them on that bigger enterprise upgrade motion and selling motion. So we get leverage there, which is why the Enterprise Advocate group can grow modestly over time.

And we get a lot of leverage just from the flywheel. We’re landing inside of these biggest customers with a high-velocity starting point that I think we’re really well-known for. And then we can use that as a more efficient leverage point to grow customers, both as we have in data center, and it’s certainly up the stack in cloud to enterprise cloud. I’ll hand it over to Mike on the M&A question, or Scott on the M&A question?

Scott Farquhar

Yes. I’ll grab it here. I think the M&A, again, we’ve been really proud of how we’ve done that. You can build products, you can partner, you can have a marketplace, you can acquire. And I think Atlassian as a company has done all those very successfully over almost over 20 years there. And when we look at acquisitions, the things we always look for is, firstly, are they aligned with our mission to unleash the potential of every team to help us get to our big hairy goal of 100 million active users. Do they fit with the values of our company? Do they fit with our business model? And then there’s a lot of long tail a lot of things we really look for. And I think we’ve been very successful with that approach and a measured approach of making sure that we bring on the companies that are really great fit for Atlassian.

As Mike and I’ve been the biggest shareholders of Atlassian, we’re aligned with all of you on this call and all the shareholders listening in terms of being good stewards of capital and making sure that we invest wisely to get the returns that all of us would want.

Luv Sodha

That’s great. Thank you.

Operator

And your next question is from the line of Keith Bachman with Bank of Montreal.

Keith Bachman

Hi. Thank you very much. I want to ask two questions. The first one is on mix and the second is on COVID. The mix question is probably for James to build on something that was asked before, but perpetual was down year-over-year, and you indicated you had some pull-ins. It actually hasn’t been down previously despite some pricing changes. And so as we look out, you said growth would moderate. Would it still be – you think positive numbers we look out over the next couple of quarters?

And the related part of that is on the maintenance side, maintenance has been steady area, call it, 20%, 21% growth for some time. If perpetual wanes, should we start to think about the maintenance side, also perhaps slowing? I would think that would be a long process. But I just wanted to hear a little bit about that, and then I’ll ask my COVID question as a follow-up.

James Beer

Sure. So in the perpetual license line, yes, we have been seeing those pull forward effects into Q2 from Q3. And I would expect other of upcoming quarters, the next couple of quarters, for example, to see similar types of pull-forward effects when we record those results. So that will drive the dynamic of whether it’s a lower percentage growth or whether it is, in fact, a shrinking of the absolute dollar figure. Again, the dollar figure is a relatively small one at this point in time because so much of the new activity is taken by our customers going straight to one or more of our cloud services.

Now also in terms of the maintenance line, clearly, we have spoken a great deal about our efforts to migrate customers from server over to cloud. And indeed, some of our server customers migrate up to data center as well. So as that continues to happen and continues to build over time, then, yes, there’ll be fewer customers executing their renewal of their server contracts. Instead, they’ll be taking on data center or cloud contracts. And so yes, you would see that affect the maintenance line over time.

But I think you’re right in characterizing that as a more gradual effect the net that you see in the license line because the license line reflects brand-new activity, either a new company coming in to buy our server products or it could reflect a current customer buying additional licenses, more users for their current licenses, that sort of thing. And so I would expect you to see the drawdown most pronounced on the license line but also a similar effect over time on the maintenance line.

Keith Bachman

Okay. Great. That’s very helpful. And then, Jay, maybe in the spirit of this is your last call, direct this one to you. When you think about or talk about COVID and the interactions with the customers, is there any sense about you could give us some dollar exposure to SMB? In other words, is that X percent of your revenues? And B, when you say that you’re having some impact, what’s the behavior there? Is it less upsell? Is it not renewing the monthly? Is there any feedback you can give on what that means in terms of behavior when you say you’re being impacted. And all the best in your future endeavors.

Jay Simons

Thanks, Keith. I’ll start, and James maybe want to tack on. I think we’ve addressed this a bunch over the course of the call, like we’ve seen largely – the impact that we’ve seen has been from the small to medium business segment in cloud, and we saw that in March and continued a little bit in April. And mostly, that is around customers either not expanding at the rate that we wanted them to, or in some cases, reducing their license counts because they reduced the size of their employee population. We’re happy – on the cost side, by the way, we’re also happy with the rate of new customer acquisition has been where we want it to be. And so I think that’s a good positive signal.

And then as I mentioned, the enterprise segment, which is a growing proportion of our business remains healthy, both just in terms of what we did in the quarter and pipeline that we’re building. And James you may want to tack on some color as well.

James Beer

No, I think you covered it, Jay.

Keith Bachman

All right. Thanks, gentlemen.

Jay Simons

Thanks, Keith.

Operator

And your next question is from the line of Ari Terjanian with Cleveland Research.

Ari Terjanian

Thank you so much for having me on the call. Congrats on the results. Two questions. First, you guys just give a little bit more impact. You touched upon it on the shareholder letter, but – and talked about collaboration. But any more examples of how customers may be using your tools and solutions to help address COVID and you think you guys will make more templates, more kind of prepackaged applications to help.

And then second, you talked about take-up of the leaderboard. Are there any areas where you see potential for the greatest share gains over the next 6 to 12 months across your portfolio? Thank you.

Jay Simons

Let me take the first one. Scott mentioned a bunch of these use cases, but I mean, we become a way to coordinate project activity content. In the case of COVID where everybody’s gone remote, I think our products become pretty critical as a way to connect people to what they’re trying to do. And so I think there’s a bunch of great use cases highlighted in the document, even when you think about something as maybe that seems little mundane is how do we get people back into our offices. I mean, that is a fairly – can be a fairly complicated amount of work with a whole bunch of considerations as we emerge from this and maybe people go back into an office and to work, and they’ve got to do things like get on an elevator, you have to consider like how desks get spaced out differently. That involves a ton of human coordination and action. And that’s typically where our products get brought in to help customers and help teams.

And maybe who is taking the second part, maybe Mike?

Mike Cannon-Brookes

Yes. I can certainly take the second part of that. Look, the question is where do we expect share gains, et cetera. Look, all of the markets we operate in, whether you look at Agile and DevOps in the software teams market, whether you look at IT and the broader sort of ITSM, enterprise service management spaces or whether you just look at collaborative work management tools whether teams are remote or not remote, right, people are going to change their work styles as a result of this.

So I would say all sort of three of our major markets, we have very small shares, and all three of the markets are growing by themselves. So we expect there to be a lot of opportunities to look there. Scott mentioned talent, it’s quite likely that this is a period over the next couple of years where there’s a higher availability of talent in different markets that we operate in geographically. That’s very important for us.

And I think what’s important is to see us just constantly optimizing our business. Again, as Scott mentioned a little bit in 2008, 2009 when we introduced the starter program, which is a little bit of an analogy to what we’ve done in free and cloud. That really sets the platform to drive a decade of growth across a lot of different markets that brought in tens of thousands of businesses to the Atlassian experience that over time grow up into different parts of our world. And those are companies you see at the moment moving from server to data center or evaluating cloud premium or cloud enterprise.

So when we talk about playing in the long-term game, that’s exactly what we mean. We believe this can have an opportunity in three very large markets that we serve, and you’ll see us continue to make moves to try to be opportunistic where we see that. You’ve seen that in free already. You’ve seen that in hiring. We’ll continue to evaluate our acquisition opportunities as we look through that. But we’re very positive about what that means to us going forward.

Ari Terjanian

Great. Thank you so much.

Operator

And your next question is from the line of Alex Kurtz with KeyBanc.

Steve Enders

Hi, this is Steve Enders on for Alex. Thanks for taking the question. I just want to get a better sense of how your partners and sales teams are adjusting to work-from-home initiatives and their ability to drive expansion within your largest customers. And secondly, I want to get a better understanding of, I think you mentioned that you’re looking to hire more people and focus more on the R&D side. But where are the biggest opportunities for investment in the product and R&D teams now? Thank you.

Jay Simons

Hey, Steve, I’ll take the first part. I mean, our sales teams – our direct sales teams are all largely inside, and so – inside teams. And so – they’re working largely either from home. They’ve did work from home in the past or they work in offices, engaging with the customers. So I think that rhythm hasn’t really changed.

Partners are in market with customers. And so I think there’s an impact there for our partners that can’t meet with customers. But we’ve been working over the past 10 years to help digitize like our solution partners. And so the way that we market, co-market with them, the way that we help generate demand in market combines both offline, which may have a little bit of a pause until we can get back to a different – the old normal. But we complemented that with a whole bunch of online digital demand capability that we will open to them. Just in terms of building pipeline and letting them serve customers, I don’t anticipate that we’ll have too much of an impact.

James Beer

Yes. And if I could just briefly interject on that, Jay, just to support that, I’ve been pleased with as I said earlier, we’ve been tracking very closely all aspects of our financials in April and partner performance has been tracking well. And one of – I guess I can comment on the second part of that in R&D.

Jay Simons

I’m sorry, I can jump in and take the second part of that in R&D. Look, we still believe we have a massive number of opportunities to invest in R&D. The highlights are certainly things like Trello and Toggl advantage of the change in work style. As more companies are working from home, tools like that are obviously becoming more valuable, Confluence for a synchronous communication, things like this. So obviously, in the product set, there’s a lot of opportunities.

Secondly, we’re in the midst of a decade-long transition to our singular Atlassian platform, the Teamwork Platform. That’s not a simple exercise. It’s going to continue to take us years to build out, even though we’ve done really good progress so far. You’ve seen lots of examples about the new collaborative editor rolling out in Confluence, which is a huge change, involves a lot of changes in identity and other key parts of our platform as they roll through different products.

And then thirdly would be in the enterprise segment, right? We’ve talked about cloud enterprise, the new addition that we put into early access program this year. That’s a massive amount of infrastructural and calculated changes in how we operate our products to meet the demands of our largest customers and scale them in the cloud. That’s not a one-and-done exercise. That’s a continued R&D investment and requires large-scale changes in our infrastructure and how we deploy products, how we work with data residency, how we work with security, how we work with our company’s own networks, et cetera, and still provide the flexible cloud products that we do and scaling for those needs. So you’ll see us continue to invest largely all across the board, but hopefully those are the three useful examples of areas where we are investing.

Steve Enders

Yes, very helpful. Thanks guys.

Operator

Your next question is from the line of Derrick Wood with Cowen.

Derrick Wood

Great. Thanks for squeezing me in. First question, James, with respect to guidance. If I look at the midpoint, it does imply sequentially down revenue for Q4. And I guess I’m just trying to understand the kind of bigger levers in driving that. Does it increase the dollar churn? Or should we think maybe there’s more trade down to pre SKUs or perhaps an acceleration of on-prem to cloud? If you could give some color there, and then I’ve got a follow-up.

James Beer

So it just points to really three different thoughts. First of all, recall my earlier comments about pull forward activity, so I would expect what we benefited from in Q2 in terms of a pull forward effect. That’s drawing from both Q3, Q4 and probably the next two quarters of fiscal 2021. So I think that’s important to bear in mind.

Yes, as Mike talked about earlier. We have fully rolled out free as the default option for our entry-level customers. So I would say that the effect there is quite modest. We guided at the start of this year to the impacts that we thought would occur from free during the year, and it was one of three components of a one-point headwind to revenue growth. And I feel as though we’re tracking well to that. And then obviously, we’ve been talking about the impacts of COVID generating the macroeconomic sort of circumstances that are impacting some of our SMB cloud customers in particular.

Derrick Wood

Okay. I guess a broader question. I mean, I would imagine there’s a lot of people that are looking for cost optimization right now. Maybe that gives you a window to attract more IT people to your platform. You’ve got low cost particularly around Jira Service Desk. So can you talk about maybe some new initiatives you guys are thinking about doing to target the IT buyer more aggressively in this environment.

Jay Simons

Yes. I mean, Derrick, we believe it’s an ongoing focus for us. IT is, as we’ve talked about, is an increasing place that we can land with JSD. And to your point, like we agree, we are, I think, a value choice and a high product quality choice. And that combination, I think, sets us up well in this environment. We’ll continue to talk about the IT service management and IT, kind of broad collaboration, service collaboration areas that we focus on, both across JSD and with Opsgenie, and with Confluence and Trello. I mean, there’s we’ve got, I think, a really rich portfolio that we can talk to IT about both to help serve the problems that they’re trying to solve internally for themselves, but more importantly, for the problems that they’re in charge of for their companies.

Derrick Wood

Thank you.

Operator

And I will now turn the call back over to Scott Farquhar for closing remarks.

Scott Farquhar

Thank you, everyone, for joining our call today. We appreciate your ongoing support, and we hope that you and your loved ones remain safe and healthy. Thank you.

Operator

Ladies and gentlemen, this concludes today’s conference call. Thank you for participating. You may now disconnect.





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Alliance Data Systems Corporation’s (ADS) CEO Ralph Andretta on Q1 2020 Results – Earnings Call Transcript


Alliance Data Systems Corporation (NYSE:ADS) Q1 2020 Earnings Conference Call April 23, 2020 8:30 AM ET

Company Participants

Vicky Nakhla – AdvisIRy Partners

Ralph Andretta – President & CEO

Tim King – EVP & CFO

Conference Call Participants

Sanjay Sakhrani – KBW

Darrin Peller – Wolfe Research

Bob Napoli – William Blair

Andrew Jeffrey – SunTrust

Ryan Cary – Bank of America

Dan Perlin – RBC Capital Markets

Eric Wasserstorm – UBS

Ashish Sabadra – Deutsche Bank

Tim Willi – Wells Fargo

Operator

Good morning. And welcome to Alliance Data’s First Quarter 2020 Earnings Conference Call. At this time, all parties have been placed on a listen-only mode. Following today’s presentation, the floor will be opened for your questions. [Operator Instructions].

In order to view the company’s presentation on the website, please remember to turn off the pop-up blocker on your computer.

It is now my pleasure to introduce your host, Ms. Vicky Nakhla of AdvisIRy Partners. Ma’am, the floor is yours.

Vicky Nakhla

Thank you, Karen.

By now you should have received a copy of the company’s first quarter 2020 earnings release. If you haven’t, please call AdvisIRy Partners at (212) 750-5800.

On the call today, we have Ralph Andretta, President and Chief Executive Officer of Alliance Data; and Tim King, Executive Vice President and Chief Financial Officer of Alliance Data.

Before we begin, I would like to remind you that some of the comments made on today’s call and some of the responses to your questions may contain forward-looking statements. These statements are subject to the risks and the uncertainties described in the company’s earnings release and other filing with the SEC. Alliance Data has no obligation to update the information presented on the call.

Also on today’s call, our speakers will reference certain non-GAAP financial measures, which we believe will provide useful information for investors. Reconciliation of those measures to GAAP will be posted on the Investor Relations Website at alliancedata.com.

With that, I would like to turn the call over to Ralph Andretta. Ralph?

Ralph Andretta

Thank you. Good morning. Thanks for joining this morning’s call to discuss our first quarter results.

We are in unprecedented times, but our organization has responded immediately and effectively to the pandemic challenge.

We’ve moved swiftly during the month of March to activate business continuity plans and implement work-from-home protocols. I’m proud of our associates and the global leadership team at Alliance Data who have completely rose to the challenge. We’re fully operational and performing well throughout this crisis.

Today, I will discuss our immediate response to COVID-19, review our first quarter results, and update you on the steps we have taken to improve our operating model with an eye towards investing in our future.

On Slide 4, you can see a summary of the actions we have taken to support our associates, card members and consumers, brand partners and clients, and of course, our communities.

First and foremost, we have taken a number of steps to protect the health and safety of our workforce. Currently, 95% of our associates worldwide are working from home. We have instituted paid leave where appropriate as well as other health and welfare accommodations to support our associates during this difficult time.

With the small number of associates who must still come to the worksite, we are paying bonuses, practicing social distancing, and staggering shifts. For our card members and consumers, we’re proactively introducing number of forbearance options, including the option of skipping the next payment without a late fee rather than enrolling in a formal hardship program. We’re also waiving late fees where appropriate.

For our brand partners and clients, we have maintained a regular dialogue to understand both their current and future needs and to support them as they too adjust their business operations.

At Card Services, we’re working with our brand partners to optimize their budgets and marketing support and shifting resources to areas that have become more relevant, like e-commerce.

At AIR MILES, we have added merchandise reward options to increase engagement as collectors’ interest shifts from aspirational items such as travel to more practical domestic merchandise and stay at home essentials.

At BrandLoyalty, we’re extending the length of certain short-term loyalty programs, allowing consumers a better opportunity to collect and redeem points prior to program exploration. The goal is to increase in-store traffic for our grocer clients.

Additionally, we immediately responded to community emergency relief needs in virtually all of our key locations, including contributing to food banks, and mental health services organizations for youth.

We allowed collectors in our AIR MILES program to donate miles to charitable organizations for relief efforts. We also accelerated corporate charitable donations planned for later in the year to support immediate emergency relief efforts and continue to match our associates charitable donations, dollar for dollar.

These actions exemplify Alliance Data’s commitment to responsible business practices and demonstrate our sustainability strategy and action as we respond to the needs of our key stakeholders during this time.

I’m proud of these efforts and our culture of partnership, perseverance, and resolve in navigating this difficult period.

Now, let me talk about the first quarter. It is best to break down this — break this down between the first two months, and then March, when COVID-19 began to have the impact on our retail partners and customers. Our business is tracking well in January and February with revenue up mid-single-digits and profitability increasing by double-digits as we benefited from higher yields, lower operating expenses, and cost reductions made last year.

As retail partners closed and travel slowed during March, we began to experience consumer spending declines, which continues today. In Card Services, our credit sales declined more than 50% as brick-and-mortar retail essentially stopped, partially offset by shift to e-commerce. At LoyaltyOne, we saw a similar story with business holding strong through mid-March, but falling-off sharply as travel-related redemption declined 90%. The combination of strength in January and February, and softness in March led to a 4% consolidated revenue growth for this quarter.

Trends at the end of March for Card Services were similar to what we are experiencing today. Retail brick-and-mortar sales were down more than 80% but e-commerce was down in low-single-digits. After the first quarter profitability, we benefited from approximately $50 million of the $150 million of cost savings we expected for this year.

Operating expenses were down $90 million in the first quarter, adjusting for one-time benefits. Tim will discuss our savings in greater detail from the actions we took in 2019.

Considering our adoption of CECL effective January 1, and the impact of COVID-19, we increased our loan loss reserves by $404 million resulting in first quarter earnings before taxes of $25 million. Based on what we know today, with April nearly over, and our current economic assessment, we believe this is the appropriate level of reserve for the economic slowdown and related loan losses. It puts us at a reserve percentage of 12%. Of course, we continue to monitor the economic outlook which remains fluid and will adjust further if necessary.

Looking at losses in the COVID-19 environment, we’re likely to see increased pressure on loan losses in the back half of 2020, consistent with the reserve actions taken this quarter. We’re also seeing increased delinquencies and requests for forbearance, which we would expect to continue given increasing unemployment.

We do expect some mitigation from the government relief programs including additional unemployment benefits and other stimulus programs. We also expect to see a benefit when the states begin to relax stay at home restrictions and begin a stage reopening. Given the uncertain climate and the limited visibility into the duration of this health crisis and its impact on the economy and consumer spending and consistent with other companies, we’re suspending our guidance for 2020.

Our priorities are to protect our liquidity, to work proactively with our customers and partners, and to be ready for a phased reopening of the economy. We continue to proactively manage the business with an eye toward enhanced liquidity and competitive positioning. We’re not taking our eye off the ball on strategic repositioning and continue to look for operational efficiencies, cost management improvement through the eyes of a fresh CEO.

We’re taking prudent steps today to strengthen our financial position and mitigate risks we may face during this next several months. To that end, we announced a reduction of our quarterly dividend to $0.21 from $0.63, which will reduce our annual dividend by approximately $80 million. Further, unlike many other publicly traded companies, we have suspended our share buyback program.

We also have a number of other levers we can pull as needed to add to our liquidity and reduce our expense base. Tim will speak more fully regarding our liquidity.

But I want to remind you of what I said last month. We have over $1 billion of liquidity at the parent level, with no near-term maturities on our approximately $3 billion of debt.

We continue to rigorously stress test the business prudently using more aggressive cases that we model even a month ago. Based on our underlying assumptions of large reductions in GDP, increased unemployment, less disposable income, and lower retail spend, the outcome is the same. We’re cash flow and EBIT positive under some fairly dire economic scenarios.

To navigate through the current period we’re focused on prudent credit and risk management, near-term expense reduction, and investing in our business strategically. For credit and risk management, we have put our recession readiness plan into action and continue to move through its stages. Compared to 2009, we believe our portfolio is better positioned today as it is more diversified and we have enhanced our scoring model, which stratifies literally a dozens of different metrics. We also skew towards a higher percentage of prime card members today. We have proactively implemented our forbearance programs which are being actively embraced by our card members. Since the middle of March nearly 3% of accounts and 4% of balances have engaged in this program. It’s still early days, but we expect this program to continue to grow.

As part of our recession readiness plan, we’re managing towards higher credit scores and have tightened our customer credit. Consequently, our credit exposures are down by 25% from the start of the year. We also closed inactive accounts to further limit credit exposure.

We have taken a disciplined approach to expense management and operations. Actions have already had been taken as evidenced by the $150 million of savings we expect for 2020 and we have identified and begun to execute on over $100 million of additional cost savings. These savings will come from adjustments in marketing spend, renegotiation of contracts, and operating expenses, all while maintaining our service levels.

Finally, as we focus on our future, we continue to explore strategic investments for our business. Areas of interest include digital and information management, new customer-facing products and services and continuing to enhance our recession readiness capabilities.

To sum up, we’re pleased with the early progress made on repositioning Alliance Data and generating cost savings, which was evident in strong performance we had in the first two months of this year. Our business continuity plan is functioning well. We have taken actions to further manage our risks, strengthen our liquidity to improve our resilience, and identify additional opportunities to reduce our cost structure. Importantly, we continue to thoughtfully evaluate strategic investments that would enhance our business in a post-pandemic environment.

Now I’ll turn the call over to Tim for a more detailed review of our financials. Tim?

Tim King

Thank you, Ralph, and good morning, everyone.

Let’s turn to Slide 5, where I’ll start with an overview of our consolidated results. Revenue grew 4% in the first quarter driven by higher yields in our Card Services business, and consistent with our expectations. We also saw increases in our LoyaltyOne segment when adjusted for currency fluctuations in the sale of Precima.

We benefited from large expense savings across all areas of our business, including corporate, card, and LoyaltyOne. And all the expense initiatives we undertook last year generated approximately $90 million in direct operating savings. As Ralph discussed, we made significant improvements in our payroll, facilities, and marketing costs. However, income from continuing operations was down 83% year-over-year. The driver to this decline was our provision expense up $404 million as we stepped up our reserves considerably for potential future losses.

Looking at the business pre-provision demonstrates the underlying business benefited nicely from the revenue and decreased expenses. Pre-provision, earnings before taxes was up $216 million or 46%.

Net income and net income per diluted share were down 80% and 78% respectively consistent with our increase in provision expense.

Let’s turn to Slide 6 where I’ll discuss LoyaltyOne. Revenue for this line of business was down 3% to $198 million and adjusted EBITDA net increased 5% to $58 million. Adjusting for Precima which was sold in January of 2020 and the effects of the currency fluctuation, revenue increased 7% and adjusted EBITDA increased 6%. Breaking the results down further, AIR MILES revenue excluding Precima increased 1% on a constant currency basis, primarily due to an increase in brand revenue associated with strong issuance growth. AIR MILES issue increased 5% in the first quarter with strong increases in January and February prior to the falling in March due to the COVID-19.

BrandLoyalty’s revenue increased 11% on a constant currency basis due to a strong performance in our grocery clients. A strong start to 2020 was tempered in March as clients reduced promotional efforts due to an already strong store traffic and redirected focus on sourcing.

Moving to Slide 7, I’ll review the underlying card metrics. Credit sales were down 3% on the first quarter. As Ralph mentioned, heading into March, we are trending towards high single-digit growth. In the month of March, we saw clear downward pressure on our sales. As we sit today, activity remains down almost 50% year-to-year. Normalized card receivables, which include held-for-sale receivables, were down 1% on a quarter to $18.6 billion. We saw pressure from the sales tail-off late in the quarter prior to this; we’re trending towards low-digit growth.

At the end of the period, end of period receivables was $17.7 billion were up 5% year-over-year and as expected; this is due to the ramping-up of our 2019 vintage.

Gross yield was 25.5% up 140 basis points due to the slowing growth and the ramping up of new receivables.

Operating expense as a percent of receivable including mark-to-market adjustments was 8.2%, down 130 basis points year-over-year benefitting from the cost reductions we have discussed.

Our principal loss rate was 7% up 60 basis points and consistent with our expectations at the start of the year. Our delinquency rates of 6% was up 80 basis points. We do expect both our principal loss rate and our delinquency rate to increase as we’re seeing deterioration owing to the effects of COVID-19 and the lower denominator due to lighter sales. We would expect related charge-offs to be evident in the second half of the year.

Finally, our ROE of 18% was down from 32% a year-ago. This also is solely a function of this significant increase in allowance during the first quarter.

Turning to Slide 8, I’ll review Card Services financial results. Card Services revenue increased 5% but earnings before taxes and adjusted EBITDA were down 88% and 84% respectively, entirely due to the increase in provision for loan losses.

Our first quarter provision was $656 million, up 160% or $404 million from last year. This led to an adjusted EBITDA net of $47 million and earnings before taxes of $32 million.

Operating expenses of $385 million were down 24% year-to-year, embedded in these savings, in the cost reduction for marketing, payroll, facilities, and consulting expenses. Adjusting for the mark-to-market gain on sale, our operating expenses would have been $401 million, which would be $44 million or 10% better than last year.

Moving to provision expense, there are a couple of call-outs. First, as we expected charge-offs were up year-over-year. However, the big increase on our provision expense was the allowance build. For the quarter, we added $336 million to our allowance to the P&L and another $644 million through the CECL adoption for a total increase in allowance of $980 million. Our quarter-end allowance is now 184% of where it ended at the end of 2019. In total, we now have $2.15 billion in allowances, which is over 12% of our end-of-period receivables of $17.7 billion.

The last item worth noting on this page is our funding costs. There was a slight increase year-over-year with the 4%. This is driven by a modest increase in our cost of funds. Our cost of funds increased to 2.4% this quarter from 2.3% one year-ago.

Let’s turn to Slide 9 and I’ll give you an overview of our liquidity. Starting with the company, at the end of the March, we had $1.1 billion available liquidity, which was a combination of $588 million of cash on hand and $500 million available on our revolver. In addition to the healthy liquidity position, out of abundance of caution, we’ve taken additional steps to strengthen our balance sheet. Consistent with others, we have suspended our share repurchase program and we have reduced our dividend. As Ralph mentioned, we’re looking at a number of other avenues to further reduce our costs, which would improve our income and cash position.

Turning to the banks, there too we are well-positioned. Cash on the banks is $3.9 billion; they have $2.5 billion in equity, a very strong capital ratios even after paying a $75 million dividend to the parent. We’ve not encountered any issues raising deposits, where we have been active in both the retail and broker markets. We have also been successful in the securitization market where we recently renewed $2 billion of capacity. To summarize, we feel the core businesses, while hurt by the pandemic, are still functioning well and making money. We provided for a substantial increase in charge-off through our provision for loan losses. Our banks are well capitalized and have large cash position. At the parent level, we have plenty of cash and liquidity. We’ve taken further steps to manage expenses and do not have any refinancing risk for almost three years.

I’ll now turn it back over to Ralph.

Ralph Andretta

Thank you, Tim.

In closing, I started my tenure with Alliance Data halfway through the first quarter and approximately one-month prior to the onset of COVID-19. I’m immensely proud of the immediate and successful mobilization of our teams and the response efforts which continue.

It is also not lost on me that next to protecting the health and safety of our associates during this time, earning the trust of our valued investors and analysts is among my top priorities. As such, I have been and will continue to be committed to being accessible and communicating transparently and directly with this important stakeholder group.

Alliance Data was moving forward on a path to reposition business consistent with our strategic review and to emerge more from — and to emerge from this crisis in a more efficient competitor. At the same time, we’re thoughtfully investing in the future. We’re working hard to do all of this while continuing to support our key stakeholders in any way we can and show we are a partner of choice.

As I said on the March Analyst call because of prudent and proven actions to responsibly manage all aspects of our operations, Alliance Data has come through many tragic and economic events better positioned, I am confident this will be no different.

We’re managing through the COVID-19 environment. We’re implementing a more efficient and effective operating model and thoughtfully investing in the future.

With that, thank you, and we’d be happy to open up the line for some questions.

Question-and-Answer Session

Operator

[Operator Instructions].

Our first question this morning comes from Sanjay Sakhrani from KBW. Please go ahead.

Sanjay Sakhrani

Thanks. Good morning and I hope you guys are doing well. I wanted to ask about the reserve build assumptions first. If I’m doing my math correctly, based on sort of the day one assumptions you made for the CECL build, you’re assuming about an 8% charge-off rate under the recessionary view that you have. Do you guys think that that’s appropriate maybe you can just talk contextually about the macro assumptions you made and sort of where you expect the loss rate to pan out under the scenario. And I think if you hear some of the other issuers and banks that have reported they’ve said, the macro forecast has actually deteriorated since quarter end, so maybe you could just speak to what that might mean for you guys as we look into the second quarter? Thanks.

Tim King

Hey, Sanjay, thanks for the question. Actually, let me start with the end of your question and work my way backwards, which is we actually clearly see the economy, as we set that CECL later in the month and I think some of our competitors. So we did have a pretty good work into mid-April thinking about all the economic environments. And of course, when we set the CECL it’s going to be a variety of economic indicators, but like a lot of our competitors we stressed that, we stressed it, we stress GDP, we stress unemployment, pushed our unemployment rates and some of our stress is north of 10%, some of our GDP, I guess contractions are 30% depending on the quarter.

So we did stress it variety of different ways. We felt we had a pretty good look late in the quarter, late the meaning as into the first couple weeks of April to set that. We did not set a specific charge-off numbers, we looked at the economic overlays, we looked at whether delinquencies were to set our CECL level.

Sanjay Sakhrani

Okay. And then are you what you’re assuming a recovery inside your macro assumption?

Tim King

Yes, we are. So we think that we should start coming out of this on a rolling basis at the end of Q2 starting to get back to some type of normalcy towards Q3. We did, of course stress that to make sure that we’re being conservative on the CECL side of that, but we did expect recovery by the latter half of the year.

Sanjay Sakhrani

Okay. All right, great. And I guess second question for Ralph. I know you had embarked on a listening tour. And I know unfortunately, we’ve thrown a wrench into sort of what you might have decided at the point that you finished it or concluded it. But you’re pulling guidance. And obviously, a lot of structural change might occur over this situation unfolding. I’m just thinking at a high-level, how different ADS might look based on your preliminary review and what you might see unfolding given you’ve been around in previous recessions? Thanks.

Ralph Andretta

Yes Sanjay. Hope you’re well as well. I think a couple of things. I just wanted to take a step back. Yes, I joined ADS because it was a company that had really good bones and had really good reputation that had been, had a couple of bad years. And my view was this was an organization that we could certainly move quickly without the bureaucracy of a larger organization. And I still believe and see that, so for me, obviously my listening tour got — my listening and discovery tour cut a little short, but the way we responded to COVID-19 really gives me a lot of confidence that we can become a more efficient and effective organization going forward.

We’re able to pivot, reduce our operating costs and improve our margins as we go-forward. But as importantly really invest where we think we — where the consumer is going to be. So digital and online was investments that we’ll continue to make, I think the evidence that they read more important is clearly here and we’ll continue to invest there in customer-facing capabilities and continue to move to digital and mobile. So my thesis hasn’t changed and I think this is really put a spotlight on why our investments are important in the near-term.

Operator

Our next question comes from Darrin Peller from Wolfe Research. Please go ahead.

Darrin Peller

Hey, thanks guys. Maybe just to help us understand, revisiting the structural opportunity versus risk for someone like yourselves in the sense that, I think you guys have spent a lot of time and investment over the years on being able to help your clients or your merchants with as you mentioned just a minute ago omnichannel. I would be curious to hear the kind of demand you’re getting right now from the end market for that upgrade, what you can do to help them out and maybe on the other side of all this maybe any type of new percentages or numbers that give us a sense of what part of your portfolio you think would be really able to survive and benefit from those trends around omnichannel those technologies that you can help them with versus those that really are relying on just physical brick-and-mortar without any type of on demand or omnichannel capabilities?

Ralph Andretta

Yes, it’s Ralph. So we are in constant contact with our partners and ensuring that we are assessing what their needs are, assessing how they want to move forward. So the shift of our — some of our marketing resources to online was clearly evident and continued switch to ensuring that we have the right online capabilities is our focus going forward.

No matter where the customer shops, whether it’s in the mall or in their living room or on their phone in their car, we’re going to be there to provide the right capability for them to have bigger baskets and have that ability to get engaged with the brand. So, for me, it’s about helping our Brand Partners, enhancing their customers experience with that brand. So I view this as certainly an opportunity to enhance our digital capabilities.

I think in terms of bricks-and-mortar, 25% of our sales or portfolios probably bricks-and-mortar and but they’re also coupled with each of those bricks-and-mortar organizations certainly have online capabilities. And that’s what we’re helping our Brand Partners focus on now, which was online capabilities.

Darrin Peller

Okay, all right, now that’s helpful. So I mean look segmenting the portfolio for us. We’re all trying to figure out I think most investors are kind of looking through the second quarter right now and probably the 2020 to some degree, you mentioned your liquidity is in a sound position to take advantage and kind of weather the storm. So we’re trying to figure out structurally what a) what size, someone like ADS can be on the other side of all those and then structurally if you’re going to be able to win end market share helping these merchants or maybe others out and it sounds like this has in demand — demand is coming in already and these conversations already having to help along those process?

Ralph Andretta

Yes, I mean good times or bad. We’re always in conversations on merchants to make that to and partners to enhance their sales, enhance their market share. Now it’s a matter of talking to them too, plan their emergence from this, how they’re going to emerge on this when — making sure we’re coordinated with the time and making sure we’re there, where they need us most. And right now, the way they need us most is the capabilities online. But we are working with them on a pretty regular basis to talk about these reopening during the course of this year.

Darrin Peller

Yes, all right. And just last question, I know Sanjay touched on this, but with regard to credit quality? Look, I mean, you mentioned in the prior cycles, I remember also just seeing key charge-offs in around 10%. I’d be curious, what’s the dynamic in this environment that would give you confidence and what kind of rate should we be thinking about it maybe is it potentially something that could be 12% to 14% or any thought process on that?

Ralph Andretta

So as I just think going forward, we’ve stretched our business to the last recession. And I think that’s a — it’s a good barometer for us and through every stress test or every dire scenario, we are cash flow positive and EBIT positive as we exit 2020. That said there are certain things that are available to our consumers now that weren’t available during the Great Recession. The economic stimulus to the consumer wasn’t available during the Great Recession, it is available now. And early days where we’ve seen some good pick up when those stimulus checks came out in terms of our customers and card members reaching out proactively to make payments. So it gave us a bit of confidence in early days, but certainly people are certainly meeting their obligations.

Operator

Our next question comes from Andrew Jeffrey from SunTrust. Please go ahead.

Ralph Andretta

Hey Andrew, you break it up a little. Hey Vicky, go to the next question, we will see if we can get Andrew back in.

Operator

Next today is Bob Napoli from William Blair. Please go ahead.

Bob Napoli

Thank you and good morning and also hope everybody’s well. I will just recall going back to the last recession with charge-offs peaking at 10%. I think the market; the stock market grossly underestimated the profitability at higher charge-off levels. And I think, the company was able to stay profitable even materially higher charge-offs. What is the maximum charge-off rate that this company can withstand for say a period of a year without having significant losses and liquidity challenges?

Tim King

Yes, look, so clearly we test our banks at a variety of different stress tests. It’s going to depend on how long we tested it back to the last recession, we remain profitable and cash flow positive, it’s going to be a combination of both that charge-off rate as well as what happens with sequels for liquidity and cash positions. But we tested it for a variety of different scenarios including the peak charge-off we saw in the recession, decreases receivables, receivables staying flat in all those cases we stayed cash flow and income positive.

Bob Napoli

Okay, what are you seeing so far in April from a payments perspective? What should we expect out of the payment rate? Or I mean, have you seen, you have due dates throughout the month, I mean have you seen any significant — what type of change have you seen in payment rates delinquencies as we’ve gone through April?

Ralph Andretta

This is Ralph. So in terms of payment rates, Bob, we’ve got payment rates year-over-year, our payment rates have not gone down. So payment rates are essentially stable. We’re seeing people proactively reach out to us to make payments. Now people are proactively also looking at forbearance programs. But that said the forbearance programs people are taking advantage of are shorter in duration, 30 or 60 days as opposed to a 12-month forbearance program. So we’re seeing people actively want to get a little relief but also engaged in terms of paying their obligations.

Bob Napoli

Thank you. That’s helpful. And the 50% decline in spend volume that you’ve seen in April, is that I mean what percentage of your spend is currently e-commerce and online and have you seen — did that trend is it continuing to decelerate or has it bottomed out?

Ralph Andretta

I talked about in my opening comments; we’ve seen a 50% decline in bricks-and-mortar. But we — in the beginning we did see an uptick in e-commerce or e-commerce, we spend is about 30% to 40%. That’s where we see — that’s where we pretty much land on e-commerce spend. Now that’ll fluctuate, but we’ve seen that increase a bit during the crisis.

Bob Napoli

And I guess again through the month of April, that — so the 50% was bricks-and-mortar, so it’s a combination e-commerce though overall blended, you’re down, you’re down 40-ish and again, can you give any color on the trend over the month?

Tim King

Yes. So what we’ve been seeing is, yes, similar to the end of March, we’ve seen our collective sales down 50%, bricks-and-mortar down almost to nothing 10%, 20%, 90% mean 10%, 20% and we’re making the rest of that up on our e-commerce group. And our e-commerce is actually down slightly but doing pretty well.

Bob Napoli

Okay. And I guess last question just and I guess the follow-up I guess on the customer base and is there any — I mean what is your confidence level that I mean obviously, this is an unprecedented environment that your customer base, I mean what percentage of your customer base do you think is at risk? So I mean, is this company 30% smaller coming out of — in a potentially like in a worst case scenario a 30% smaller company coming out of this before you have to grow on top of that or just any feel for what percentage of your customer base is at risk? Is it more than 30%?

Tim King

So, are you referring to our retail partners or consumer in the card, the retail partners?

Bob Napoli

Yes, the retail partners, yes.

Tim King

Yes, a good question. We’re obviously watching that very closely. It’s tough for us to tell at this point, because we don’t know what type of government support any of our retail partners will get, what type of forbearance on their rent payments. Certainly, we expect it to be smaller. We’ve run some stress, but just it’s too early for us to tell because we just don’t know how it’s going to affect our retailers, the post the type of help they’re going to get from the government from their forbearance programs, debt, rent, et cetera.

Bob Napoli

And you can under a smaller business, you can maintain, you can hit targeted returns, obviously you have work to do on the organization?

Tim King

Sure. There’s one thing — clearly Ralph and I have a very, very sharp focus on is going to be the expenses and making sure we have the expenses. Luckily, this doesn’t snap overnight, so when they start seeing the sales start dropping or receivables start dropping if that were to ever happen, we can adjust our cost basis into that. So relatively low fixed overhead is going to be the variable associated with the attrition we might have to have in a call center, natural attrition to match if the receivables drop, but a small base, yes, we could be profitable and we would be profitable.

Operator

Our next question comes from Andrew Jeffrey from SunTrust. Please go ahead.

Andrew Jeffrey

Is this better guys, I will try again.

Ralph Andretta

Andrew, much better.

Andrew Jeffrey

Okay, excellent. I appreciate your patience with me. I wonder, Ralph, if you could elaborate a little bit on underwriting standards. I know you mentioned curtailing some credit lines and this is a dynamic environment. You heard at least one credit bureau this week talk about the challenges of trying to ascertain employment and income given furloughs and compensation cuts and things like that. I know historically, Alliance hasn’t used FICO scores necessarily to underwrite, are there specific changes and assumptions, you’re making in your underwriting criteria that try to account for sort of the dynamic environment today where people may be out of work for a little while and come back and variable incomes and things like that, how are you going to think about risk management in that kind of world?

Ralph Andretta

Yes, so I’ll just talk about our underwriting strategy and how it’s evolved. So today, our card members look much different than they did in the past. And we believe our portfolio is more resilient than it was during the recession. The changes have been driven by both, a product diversification. We started several years ago, underwriting changes we started making about a year-ago which indicates potential economic slowdown. So, we constantly look it’s not that we have a knee jerk reaction to what happened. We constantly looking to enhance our models, our scoring models by upgrading to a newer version of trivial score. And continue to find add on scores focused on foreign prevention, synthetic identities, and credit file customers and other elements.

In 2009, our underwriting changes we’re focused on finalizing scoring enhancements, raising minimum due scores for new applicants and reducing contingent liability by closing inactive accounts or scaling back. That said we’re first certainly very diligent on, we’ve tightened our underwriting criteria, but also we’re a responsible lender, we’re not going to go out there and offer credit lines or for product to those that do not have the capacity to pay.

Andrew Jeffrey

Okay, well, good to hear you’re proactive; I think that was good foresight. And then with regard to forbearance, and I know it’s early days and encouraging perhaps that you’re not seeing some of your borrowers really want to stretch out to 12 months for example, I’m just thinking back to the experience with Harvey and the sort of bubble it created in delinquencies that lasted I think a lot longer than maybe you expected at the time recognizing more at the company, is there a risk that we’re still talking about COVID-19 elevated delinquencies and/or losses a year from now, 18 months from now, I guess. What — how do you probability weigh the outcome of this just drags on for a protracted period?

Ralph Andretta

Again nobody could predict what’s going to happen over a protracted period, particularly with a something we’ve never really faced before. But my view is, there are more resources today than it had been this past — past crises, whether it was hurricanes or other economic crises you see. The assistance to the general public, our ability to react quickly offering programs that are more flexible than they’ve been before, I think will certainly curtail that bubble long-term.

Operator

Our next question comes from Ryan Cary from Bank of America. Please go ahead.

Ryan Cary

Good morning. Hope you’re all well and thank you for taking my questions. Just wanted to drill on Andrew’s question a little bit, I think on the Update Call you mentioned majority of customers applying for forbearance up to that point had opted for shorter-term programs and that these customers are more likely to end up current on their loan. And so how has that changed since late March? And if it has, how do you think about the inferences as a result of that and the impact on the business?

Ralph Andretta

It hasn’t changed. So we’re seeing — we’re seeing customers proactively want a shorter, a shorter forbearance program and in fact wanting to just skip a month payment, rather than going to a forbearance program. So that’s what we’re seeing, it is early days; these programs are just getting up and running. As I said, right now they’re in the low — low-single-digits, but we expect them to probably settle in the low double-digits as we move forward.

And so, it really hasn’t changed yet a little bit too early to tell. What we’re seeing though in the month of March our payment rates are holding to what we have predicted and we’re seeing based on the first wave of stimulus checks; customers have a willingness to make payments.

Ryan Cary

Got it. Okay, it sounds like before you’re expecting to see pent-up demand and potential bounce back once the COVID situation is under control. Now it feels like this is a little bit more wait and see, is this just due to the duration and severity of the slowdown? Are you seeing anything else changing over the past month that would lead you to think the recovery might take a little longer?

Ralph Andretta

I think people are optimistically looking at the recovery as May 1. But as you can tell publicly the recovery is going to be a stage recovery over a period of months. So it’s going to be a ramp-up rather than a Big Bang. And certainly we’ve stressed our business model for that. And under those scenarios, our business model is still EBIT and cash positive for the year.

Ryan Cary

Got it. And just to make sure I see clarifying question on that. I know before you were talking about the stress scenarios as retail sales down kind of 25% extended for 12 months, is that still the same zip code in these most recent stress examples?

Tim King

Yes, we’ve stressed it down 25% for the year to go. So that’s actually more like 33% — actually 25% on the full-year, which is more like 33% on the year to go. So that was one of the stress scenarios we ran.

Operator

Our next question comes from Dan Perlin from RBC Capital Markets. Please go ahead.

Dan Perlin

Thanks. Can you guys just remind us a little bit about the customer concentration risk that’s embedded in the current portfolio today? I mean, it really just trying to handicap, what is going to happen to the extent that we have more retail failures. So maybe you can just walk through the puts and takes that we need to be thinking about modeling in that environment?

Ralph Andretta

Yes. So I’ll do it in terms of high-level in terms of percentage of receivables. I think our portfolio has changed since the Great Recession. If you recall, probably during that time, we were in 95% private label, we’ve evolved to something less than that. So 50% of our portfolio is retail goods and private label, 25% of our portfolio is big ticket items where you tend to get better credit quality and then 25% of our portfolio is co-brands where you tend to get better credit quality and general purpose plastic. I thought we’d dimensionalize the portfolio now. So certainly stronger than we were in the Great Recession and a bit more diversified than we were.

Dan Perlin

Okay, that’s helpful. And then to the extent that we have to brace for additional failures for your retail partners, over the coming months and quarters, can you just talk through the puts and takes that we need to be thinking about in the model? I know you’ve talked about the stress tests, but what are the actual outcomes or optics that we need to be thinking about? And how long of duration are you able to kind to extend off those?

Tim King

Yes. So I’ll use the most egregious the worst scenario, if we get a private label retail partner who filed for Chapter 7 goes out of business. It takes call it six to nine months for you to get a half of those receivables and then you continue with that type of halfway.

So to call we went to the consumer, not the retailer, what happens is of course, we stopped getting new sales from that retailer, if they go out of business, and it takes and then we of course make a lot of money as they unwind. But we just start losing the receivables, we lose about half of it up to six to nine months and there’s another half, six to nine months. And so quickly tried after two to three years, we don’t have that receivable. So our real risk is that we make less money on a volume basis, we make higher percent on those receivables. And then of course, it’s up to us as an organization to replace those receivables with the new partnership.

Dan Perlin

Okay, that’s super helpful. Just one other one if I could sneak it in, just for cadence on the provision expense I know I mean you had a huge reserve build. I’m just trying to think about what — what are we jumping off into and kind of second quarter as you are framing it from a plus or minus range in the provision expense in that quarter?

Tim King

Yes, so obviously, we’ll take into consideration everything we know. At the time we set that provision expense, we clearly were able to do that as we saw April unfold in the first couple weeks of April, there’s always risks if the economy continues to deteriorate or people don’t come back as quickly as we’d expect. But at this point, we looked at it and we felt very good that we factor into everything we took a nice, solid conservative look at the balance sheet and what we needed to put the reserves at the end of Q1.

Operator

Our next question comes from Eric Wasserstorm from UBS. Please go ahead.

Eric Wasserstorm

Thanks very much for taking my question. Can you hear me all right?

Ralph Andretta

Yes, we can.

Eric Wasserstorm

Okay, great. Thank you. So thank you for going through some details of the liquidity and capital position. I think in my recent experience with the stock, I think that is in fact probably the more of conservative even relative to credit quality in the current environment. So could you just maybe talk about how you’re thinking about the overall company’s leverage position at this point and whether these circumstances has caused any rethinking about that, relative to let’s say even a month or two ago?

Tim King

Sure, obviously the leverage ratio when you take that big an equity hit, to set up CECL is going to cause arbitration to go up. And you’ll see that we also took a drawdown on our line of credit. Having said that, we are concerned about the leverage ratio, we’re not tossing and turning about it. We have enough cash flow to cover that, we’re comfortable with that, it is clearly something Ralph and I will need to adjust — address, excuse me, long-term. But at this point, the leverage ratio from our perspective is, first and foremost, we feel comfortable that we can pay our debt service, we feel very comfortable that we can.

Eric Wasserstorm

Great. And just as a follow-up on the — in terms of the subsidiary banks position, do you think that — do you anticipate any challenge to continuing to upstream dividends to the HoldCo based on the near-term operating outlook at the subsidiary level?

Tim King

Sure, obviously, one of the things we’re going to watch very carefully is the banks and their capital position. I said before, and I know Ralph and I’ve had the conversation. First and foremost, we want to make sure we have very robust balance sheets for both the parent and the bank. The bank being part of that, the part of course, the reason we called out the total leverage ratio at the bank of that 16.7%. The banks have been profitable, they were profitable throughout the recession, we expect them to continue to be profitable. The — then the question becomes a growth versus the income if this recession plays out one way that we might see it, which is decreased sales lead to decreased receivables, and actually allows us to dividend up more capital. And in that we don’t have as much receivables we have to hold capital again. Again, we’re going to be very prudent make sure our banks are very well-positioned, very heavily capital intensive. So that they can withstand shocks like this. So there’s a variety of different scenarios we run. In most cases, we feel the banks would be able to upstream some cash to the parent.

Eric Wasserstorm

And just one last one on this topic. I know that obviously we’re understandably, it’s sort of in crisis mitigation mode, but over the longer-term Ralph, I’d love to understand your philosophy about earnings growth versus tangible book value accretion and how you think they’re, if you think that tangible book value accretion is an important role in the value creation for ADS?

Ralph Andretta

Yes, I think a couple of things. So let me just say this, the safety and soundness of our banks is influences every decision we make. And I think even through the crisis here, where we’ve taken prudent measures to enhance our capital position, cut expenses; I think those are really important — important actions we’ve taken to ensure the safety and soundness of our institutions. I think from — from my perspective, predictable, sustained good growth on top-line and bottom line is what we’re looking for long-term, and I think that will sustain, that will sustain our safety and soundness and assets in the bank.

Operator

Our next question comes from Ashish Sabadra from Deutsche Bank. Please go ahead.

Ashish Sabadra

Hi, thanks for taking my question. Just a quick question on the March data, was there any benefit from the forbearance program on the delinquency in the charge-off. Is there a way to quantify that?

Ralph Andretta

Yes, so it’s very early. I will tell you, but what we have seen as I think I mentioned it earlier, the payment rates as I compared them to last year are virtually the same. And we’re seeing our roll rates are, where they thought they would be probably a little bit better and we saw a, when the first stimulus checks came out, we did see incremental phone calls and incremental payments come in during that period of time now, that does not make a trend. We’re still managing it very closely, but we did see some improved activity or increased activity.

Ashish Sabadra

That’s helpful. And maybe just as you think about again, the charge-off and charge-off trend going through the year, Ralph, as you mentioned charge-off could potentially go up in the back half as more consumers come out of the forbearance. And also as we see a higher unemployment rate, but is there a way to think about all the puts and takes and potentially some impact from any potential retailer bankruptcy, but as we think about going into the back office, is there a way to think about where that could head to in all the puts and takes going into the back half of the year? Thanks.

Ralph Andretta

Yes. I think as I think about the back end half of the year, we traditionally see loss rates come down, we’re going to I believe see elevated loss rates. I think what we’ve — the actions we’ve taken in the first quarter to reserve, I think are appropriate for what we are, what we are projecting in the balance of the year. That said, it’s a very fluid environment and if things change, we will certainly adjust accordingly.

Operator

Our next question comes from Tim Willi from Wells Fargo. Please go ahead.

Tim Willi

Thank you and good morning. Just had one question. If we could talk about e-commerce a bit, I understand that probably a fair amount of your retailers are probably in the discretionary bucket, which is going to obviously impact the overall volume. But we’re obviously seeing from some retailers stories of exceptionally strong e-commerce and digital et cetera. Is there any way that you could just sort of comment or discuss where you think your retailers are with their digital commerce plans? And are they punching after weights? Or do you think that some of these retailers are still reacting and they’re still better experiences and better volume to come from them as they really reposition their businesses for more digital and e-commerce and maybe they otherwise would have expected six months ago or a year-ago?

Ralph Andretta

Yes, I would categorize it probably as a mixed bag. I think we have some good partners out there that have really good retail, really good sites. I mean I’ll just cite like Sephora for example. But there are certainly, this has been a opportunity for them to rethink their strategy and ensure that they have a robust e-commerce, e-commerce channel which plays right into the investments we’ve been making and the investments we’re going to continue to make to be even more relevant in e-commerce for our partners and our customers.

Tim Willi

And if I could just ask one quick follow-up, I guess sort of some stories and chatter out there about the Victoria’s Secret transaction and whether or not that will occur, is there anything that we should be aware of or think about relative to that deal closing or not closing as it might impact anything with ADS?

Ralph Andretta

It’s difficult for me to comment on both in the news over the last couple of days. Victoria’s Secret has been a partner for a very long time, I think we will continue to be a partner down the road, I think we’ll work with them and we’re set to work with them in their current capacity. We’re set to work with them in a future capacity and we’ll continue to be a supportive partner.

Operator

This concludes the question-and-answer portion of our call. Now I would like to turn it back to Ralph for final comments.

Ralph Andretta

Well, thank you all for participating this morning. I know this is very difficult circumstances and we are in many different locations as opposed to Tim and I being in the same room. Thank you for your time and as I said this is an important stakeholder constituency group for me and I intend to be available and certainly transparent as we communicate going forward. Everybody have a good day and thanks again.

Operator

Ladies and gentlemen, this concludes today’s conference call. Thank you once more for participating. You may now disconnect.





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